When the US administration launched its first salvo of tariffs in early April, there was a real fear in Europe that the progress the region had made on lowering inflation and fostering growth could be completely lost.
The market reaction on May 23 to threatened 50% tariffs on Europe shows that trade war anxiety remains alive and well. Let’s look at three possible positive ways to look at the current malaise.
Tariffs May Hurt the US More Than Europe
However, the backlash from tariffs has thus far fallen much harder on the US than Europe, with the US economy going backward in the first quarter of the year. And the risk of rising inflation from tariffs has stopped the Federal Reserve from cutting rates. This contrasts strongly with the eurozone, where rates have been cut three times already this year.
Equity market flows too have reflected changing sentiment, with a rise in flows to global funds that exclude US stocks. Some of this is down to valuations, with the US equity market close to fair value based on our estimates. But it does reflect a change in investment preference as well as performance. Many large investors have expressed the view that policy risk is now high in the US and that it simply makes sense to diversify by adding exposure to other regions.
Q1 Earnings Season Was Robust
European companies performed strongly in the first quarter of the year. When we exclude the drag from lower earnings in the energy sector, European companies reported earnings growth north of 7% year over year. Let’s look in detail at the sectors:
Financials: Interest rates may be falling in Europe, but the change has come at a much slower pace than economists had previously predicted. Also, while the ECB has recently cut rates as low as 2.25%, in the UK rates are still high by historical standards at 4.25%. UK banks in particular have been able to leverage this high net interest margin, the difference between borrowing and lending costs, to maximize profitability.
Industrials: Performances have been mixed in this wider sector, but for many subsectors like defense, increased spending has boosted order books for established firms like Rheinmetall RHM, whose fair value estimate Morningstar has recently upgraded. Firms like Siemens SIE, with exposure to structural growth themes like electrification and AI data centers, continue to benefit.
Healthcare: Former stock market darlings like Novo Nordisk NOVO B are struggling to retain market share against increased competition in areas such as weight loss. But for firms like Sanofi SAN and Roche ROG, growth in key products remains strong, while sales from new drugs in the pipeline are encouraging.
European Economic Sentiment is Not Collapsing
Mindful of the tariff effect, 40 companies reduced their full year financial guidance during earnings season. Many more firms, spread out across industries, declined to give any full-year guidance, such is the level of uncertainty. A trade deal between the US and Europe seems a long way off.
But what is perhaps most notable about the European Commission’s latest survey is that it does not show a total collapse in economic confidence in April, but merely a continuation of the downward trend, with the index turning negative back in 2022.
Perhaps the full ramifications of the April 2 tariff announcement, and subsequent pause, and now the prospect of 50% tariffs, will take a little longer to be fully absorbed by European businesses? Or could it be that European companies’ already negative view of the business environment can’t fall any further?
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
Correction: This article has been amended. The original article said that Pandora had declined to give full-year guidance, but that was incorrect.
