Europe's Disappearing Equity Rally Hit by Trump, Tech and Trade

Europe is growing at its fastest pace in a decade, its biggest economy has record low unemployment and stable leadership and even its peripheral members are starting to emerge from the region's crippling debt crisis with impressive recoveries and its central bank is committed to easy money and ample liquidity for a least a few more years.

Germany's venerable Chancellor, Angela Merkel, has recently cemented her fourth term in office in the region's biggest economy that should, along with new French President Emmanuel Macron, ignite one of the biggest EU reforms drives in a generation. Spain, which saw its bank sector bailed out by EU taxpayers in 2012, is one of the region's fastest growing economies and even Greece, which teetered on the edge of EU expulsion only two years ago, has recorded four consecutive quarters of growth.

So why are the region's equity benchmarks so deep in the red and what happen to the rally in what was, only months ago, the world's hottest stock market?

That's a question that has puzzled analysts and investors alike this year as the region's Stoxx 600 Index, the broadest measure of share prices, has slumped more than 2.5% even as the economy continues to expand and unemployment continues to decline. It's also lead, at least in part, to nearly $160 million being pulled from the Vanguard FTSE Europe ETF last week, the biggest outflow of the year, and the lowest levels of Eurozone equity allocation since early 2017, according to Bank of America Merrill Lynch.

The underperformance belies the solid underlying strength in the European Union, the world's second-largest economic bloc with more than 500 million people and annual output of more than $20 trillion. The OECD sees growth in the Eurozone, which comprises the 19 nations that use the single currency, accelerating to 2.3% this year and 2.1% in 2019, slower than its estimate for U.S. growth but still roughly in-line with the agency's view of the broader global economy.

Two easy-to-grasp answers might be linked to both the region's lack of a dynamic tech sector and the potential for its manufacturing economy heavyweights to be hit hard by President Donald Trump's recent moves on steel and aluminium import tariffs. 

Tech stocks have powered the lion's share of U.S equity market gains so far this year, with the Nasdaq Composite rising to a record high 7,588.32 on Monday, a move that takes the tech-focused benchmark's total return for the year past 5.7% compared to a 0.8% year-to-date decline for the MSCI Europe benchmark. 

Europe's biggest tech stock -- German software giant SAP SE (SAP) -- has fallen 5.31% so far this year, holding down the Stoxx Europe 600 Technology subindex to a 4.6% year-to-date gain. Collectively, however, Europe's listed tech stocks have a market value that's less than 10% of their U.S. rivals, which robs the broader regional indices, such as Germany's DAX performance index and the CAC 40 in France, from booking the kind of gains seen in the U.S. this year as investors pile into the FAANG complex as a hedge against trade protectionism and rising interest rates. 

Trump's tariffs, which include a 25% levy on imported steel and a threatened charge on European automakers if European officials retaliate, is also holding back the region's equity market potential, where more than a fifth (21.7%) of the MSCI Europe' index's weighting is comprised of industrial and materials stocks.

The benchmark's largest weight, financials, is also held back by exceedingly low regional government bond yields and near-zero interests (including a negative charge of -0.4%) held in place by the European Central Bank. 

Neither condition, at least at the moment, appears set to change: ECB President Mario Draghi confirmed the Bank's dovish stance last week, insisting that "an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term".

Trump's move last night to block an attempted takeover of U.S. wireless systems expert Qualcomm Inc. (QCOM) by Singapore headquartered Broadcom Inc. (AVGO) , on national security concerns suggests his "America First" campaign rhetoric is slowing crystallizing into government policy that could hamstring EU earnings growth, given that around 16% Stoxx 600 company revenues are generated in the United States.

Ouch! McKibbin & Stoeckel calculated that a minor trade war where tariffs rise 10% across the board would cut global GDP growth by 1-4.5%, w/ US losing 1.3% & #China losing 4.3%, #Germany 3.8%. A 40% change in tariffs would cause a deep global recession. https://t.co/BPMZ6R6qhc pic.twitter.com/vRFRLgGoEY

— Holger Zschaepitz (@Schuldensuehner) March 11, 2018

European stocks have been hot for the past year --  providing a 21.5% total return over the past 52 weeks, well ahead of the S&P 500's 17.09% tally but notably shy of the Nasdaq's 26.3% total -- but with Trump on the march and tech on the rise, 2018 isn't likely to see the #Euroboom's regional recovery translate into winning equity returns.

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