Select Page

Authored by Bloomberg's Justina Lee

What explains the resilience of Europe’s equity recovery this year despite worsening economic data and political wobbles?

The obvious candidates are the excessive sell-off in late 2018, an ECB that’s likely to stay loose for longer and optimism over U.S.-China trade talks. But when the Stoxx Europe 600 is at the highest since October, just a trade platitude away from its 200- day moving average, you’ve got to wonder how much support you can still count on from those three factors.

Let’s start with trade. Trump received a report on whether imported cars could pose a national security threat on Sunday, once again raising the specter of higher U.S. auto tariffs. That should at least be a drizzle on the parade of positive comments on ongoing U.S.-China trade talks. Markets have been cheering every ostensible sign of a compromise that would at least delay the threatened increase in American levies on Chinese goods. But how much higher can stocks go on this basis, when a grand bargain covering thornier issues such as intellectual property remains unlikely?

“It’s going to be a can that’s going to be kicked further down the line and an avoidance of short-term escalation, which will probably lead to a sigh of relief in the markets, but it won’t go away,” says Dirk Thiels, head of investment management at KBC Asset Management NV in Brussels.

Meanwhile, with the Stoxx 600’s forward price-to- earnings ratio up 13 percent from its trough, the bar should be raised for good news. As results estimates get cut, forward valuations will also end up being dearer than they look now.

In this lens, European cyclicals’ year-to-date rally is a head- scratcher. Economic momentum in the region has deteriorated -- just look at bond yields and listen to ECB officials -- but here the debate is on China and valuations. The new year has seen a rebound in Chinese risk assets and expectations are for growth to improve after stronger stimulus measures. But more evidence is needed.

Some strategists argue that at least parts of cyclical sectors are so cheap that they’re bargains regardless of how macro data do. Bernstein analysts count industries including autos, mining and construction materials as “cheap cyclicals,” while “expensive cyclicals” are luxury and capital equipment. Morgan Stanley has its “cyclical cyclicals” and “defensive cyclicals.” If you have to be hopeful, be careful.

Euro Stoxx 50 is down -0.5%