Implications for European equities:
- European equities around 3% lower than our base case: In our trade war scenario, we expect Euro area PMI momentum to remain deeply negative over the coming months rather than improving to slightly positive levels as in our base case, leading to a meaningful drag on European equity performance. However, this would be partly offset by the boost from a weaker euro and lower Euro area real bond yields, leaving the Stoxx 600’s implied fair-value around 3% below our base case on average over the coming months, with a trough of below 350 by late September (10% below current levels).
- Sectors: The sectors that would see the largest declines in fair-value relative to our base case would be banks (-12%), autos (-9%), consumer durables (-8%) and mining (-8%). Banks would suffer from the weakness in Euro area PMIs in combination with lower Bund yields, while mining would see a drag from a lower copper price than in our base case, in turn a function of a stronger USD and weaker China PMI momentum. Yet, in this scenario we would remain overweight mining, given that our models would still point to 11% upside in the sector’s price relative by late Q4, while we would downgrade banks from overweight to underweight (as our models would point to 6% downside by the end of our six-month forecast horizon in our trade war scenario, compared to 6% upside in our base base). The sectors that would see the biggest rise in the model-implied fair-value by the end of our forecast horizon are pharma (+7%) and food & beverages (+6%), both boosted by lower US bond yields in our trade war scenario.
- Countries: Italy would see the biggest fall in fair-value (-7%) in our trade war scenario, as this highly cyclical index would suffer from weaker Euro area PMI momentum and lower Bund yields (a key driver of performance, due to the high weighting of financials in the index). Germany and Spain would also see declines in their fair-value (4% and 5%, respectively), largely because of the impact of weaker Euro area PMI momentum. Switzerland would see the largest rise in fair-value (3%) in our trade war scenario, primarily as a result of its inverse relationship with US bond yields. Overall, we would not envisage any country recommendation changes in our trade war scenario.
- Styles: In a trade war scenario, the model-implied fair-value of European value versus growth would drop by around 3% relative to our base case, with lower oil prices acting as the main drag. Yet, this would still leave our models pointing to upside for the trade over the coming months. Small caps versus large cap would also see a fall in fair-value of around 3%, leaving most of the six-month forecast trajectory below current levels. Offsetting this, however, is the fact that small caps’ domestic exposure makes them less vulnerable than large caps to a possible shock to global trade activity as a consequence of rising protectionism. As a consequence, we would remain benchmark small caps versus large caps in our trade war scenario.