Goldman, BlackRock warn that Europe’s stock rally faces tough obstacles

(Bloomberg) — European stocks face a number of hurdles to extending their 2024 rally after hitting another record high this week.

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Money managers from Goldman Sachs Group Inc., BlackRock Inc. and Northern Trust Asset Management warns that investors should be prepared for rising risks from the region’s weak economy and its impact on corporate earnings. The US election adds an additional layer of uncertainty.

Markets are bracing for a volatile final quarter as seemingly unstoppable growth in the first half of the year turned into highs and lows swings over the past three months. And while China’s long-awaited stimulus measures could provide fresh impetus, the stakes are high for stocks to post meaningful gains.

Equities are “sensitive at the moment,” said Helen Jewell, chief equity investment officer for Europe, the Middle East and Africa at BlackRock. “US elections are incredibly difficult to call and you have uncertainty around the macro outlook. This fragile market will continue until we gain visibility in 2025.”

A weak economic context in Europe contrasts sharply with the region’s equity benchmark at a record high. While fears of a global recession eased as investors became more confident about US growth, private sector activity in the euro zone eased this month and forecasts point to a further contraction in Germany.

This week, Northern Trust cut its European allocation to neutral from overweight, citing the worrying macro outlook.

“The economic data looks pretty choppy,” Anwiti Bahuguna, chief investment officer of global allocation at the $1.2 trillion asset manager, told Bloomberg TV. “Inflation is coming down, but not fast enough to think there would be very strong rate easing. It’s not a place to take too many risks.”

The risk of winning

Third-quarter earnings, due to start in mid-October, will be key to assessing the impact of weaker growth on consumer demand.

In an early sign of how the season might play out, an analyst at JPMorgan Chase & Co. warned that Novo Nordisk A/S’s quarterly earnings could show slower-than-expected sales of its blockbuster weight-loss drug Wegovy. Investors are also guessing on bets on retailers after Sweden’s Hennes & Mauritz AB said it was unlikely to hit a key profit target for the year.

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Expectations for full-year earnings have fallen about 2.8 percent since January, according to data compiled by Bloomberg Intelligence. However, some investors say even these estimates are too high, setting the stage for further downgrades.

“Our fund positioning is not very aggressive,” said Nicolas Simar, senior equity fund manager at Goldman Sachs Asset Management. “In the short term, there is little room for profits to improve substantially.”

Simar particularly warned about the outlook for consumer goods companies, which have been hit by falling demand in key markets such as China.

Electoral gamble

The US presidential election could have a major impact on European earnings if Donald Trump gets the vote.

The Republican candidate has proposed a blanket import tariff of 10 percent and higher taxes on goods made in China. If this leads to an “all-out trade war” and results in a “high single-digit drag” on regional earnings growth, Barclays strategists said.

German and Italian stocks, as well as the capital goods, autos, beverages, technology and chemicals sectors appear most at risk, they said.

Political unrest in France is also weighing on shares in the region, with Paris underperforming peers this year as investors lose faith in the new government’s ability to survive.

The regional benchmark also faces a test on technical indicators. Previous record highs have proved to be major resistance points, with the index failing to rise above this level four times since May.

The China Effect

China’s slate of stimulus measures could be just what the Stoxx 600 needs to jump-start its year-end rally, as companies generate about 8 percent of revenue from the Asian country.

Market strategies from Barclays and Citigroup Inc. said China’s measures were improving the outlook for so-called cyclical stocks — miners, automakers and consumer discretionary spending — which lagged behind defensives for much of the third quarter. A basket tracking European cyclical shares rose 3.2 percent this week, while the defensive gauge was flat.

Even so, earlier promises of recovery in China have been disappointing as stimulus pledges have failed to deliver a meaningful recovery. While the latest measures could have a prolonged impact on local assets, the effect on the Chinese consumer going forward is questionable, according to Northern Trust’s Bahuguna.

This also makes the outlook for luxury goods manufacturers in Europe. The sector – which relies on China for up to a fifth of its revenue – has suffered as the recession has pushed shoppers to cut back on brands, and even the latest stimulus measures are unlikely to reverse the situation for now.

Meanwhile, automakers are trying to climb out of a deep hole, with the Stoxx 600 Automobiles & Parts Index hitting its highest level since November this week. It remains the second-worst performing sector in Europe this year, behind only energy and partly affected by Europe’s trade tensions with China over electric vehicles.

Gilles Guibout, head of European equities at Axa IM in Paris, said the impact of China’s latest measures remains to be seen.

“It’s still too early to say now,” he said. “But at the end of the day, future earnings will set the market trend going forward.”

–With help from Christian Dass.

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