European indices haven’t been immune to the ripple effect caused by the recent US technology rout, and there could be further headwinds to come depending on the outcome of Brexit negotiations.
European stocks have been on a whirlwind journey so far this year. For the year to date to 17 September, the FTSE 100 was down 19.9%, but up 21.1% since its 52-week low close in March. While Germany’s DAX is down 0.3% for year-to-date, it’s climbed 56.5% since its 52-week low close in March. As for the Euro Stoxx 600, it’s down nearly 10.8% but up 32.4% in the same periods.
While US markets saw a technology-led rout in the first week of this month, which was causing a ripple effect across global markets, European stocks seemed to show some resistance. There were some exceptions, however, like the German enterprise software giant SAP [SAP], which is one of the Stoxx 600’s largest components.
YTD price drop of FTSE 100 but up 21.1% since March low
All three of the FTSE 100, DAX and Stoxx 600 rallied on 7 September as Wall Street took the day off for Labor Day. The indices then fell slightly the following morning as European markets waited to see if the US tech volatility would continue for a third day — it did, but not to the extent it had at the end of the previous week.
The indices rose again in the afternoon of 9 September as many of the US tech stocks that had been affected by the rout traded in the green during pre-market trading and throughout the day.
A plunging pound
The morning of 9 September saw the pound plunge against the dollar to a six-week low as the threat of a no-deal Brexit looms large. The pound’s weakness has been good for FTSE 100 companies that earn a significant percentage of revenue in dollars. Some of the big gainers in early trading included British American Tobacco [BATS], Unilever [ULVR] and GlaxoSmithKline [GSK].
With a large proportion of total FTSE 100 revenue —thought to be around two-thirds — earned in overseas currencies, the longer and further sterling falls, the longer and higher the FTSE 100 can climb.
“Dominated by constituents with substantial overseas earnings, the index benefits from the bump these earnings get when the pound falls against other major currencies,” Russ Mould, investment research director at AJ Bell, told City AM.
“Dominated by constituents with substantial overseas earnings, the index benefits from the bump these earnings get when the pound falls against other major currencies” - Russ Mould, investment research director at AJ Bell
The flipside to all of this is that the current volatility and turmoil hasn’t been good news for cyclicals on the DAX and the Stoxx 600.
Concerns over the outlook for oil demand has seen prices yo-yo, and put pressure on the share prices of Total [TTA] and Royal Dutch Shell [RDSA]. Another of the index’s top 10 components, AstraZeneca [AZN], also has the potential to weigh its price down. The pharmaceutical firm also temporarily halted its vaccine trial amid safety worries. Further delays or setbacks could drag the index down further.
With all these factors at play, it’s easy to see why the Stoxx 600 has only risen just over 5% since the beginning of June.
There has also been uncertainty around exports to the US. Tit-for-tat trade disagreements with the EU had seen US president Donald Trump threaten to increase higher tariffs on certain imported goods in response to the EU’s persistent refusal to lift tariffs on lobster imported from the US. Fortunately, both sides came to an agreement, which was announced on 21 August.
Failure to reach an agreement would have been particularly damaging for companies in the automotive and aerospace industries, namely Volkswagen [VOW3], one of the main companies on the DAX. The car manufacturer has seen its share price climb 11% since the agreement was reached, although it’s down 6% year-to-date.
Both German and European companies will be buoyed further if the US government can sign off on a new stimulus package in the wake of the coronavirus pandemic. This will mean businesses and consumers won’t need to cut back on their spending and so exports shouldn’t be affected.
The DAX has been in a holding pattern recently and could be set for a breakout next year, according to InvestingCube. However, the likelihood of this happening depends on the speed at which German companies can recover from the pandemic, and whether a no-deal scenario will play out.
“It is almost inevitable that the perceived probability of ‘no deal’ will escalate over the coming weeks” - Goldman Sachs analystsl/BLOCKQUOTE]
On 10 September, Christine Lagarde, president of the European Central Bank, said that the fall in the eurozone’s GDP for the full year will not be as bad as first predicted — this is due to the eurozone economy rebounding strongly over the summer. However, Lagarde’s comments were overshadowed that afternoon by the EU threatening the UK with legal action over withdrawal deal changes, leading to the pound falling to a six-month low against the euro.
In a note to clients, Goldman Sachs analysts wrote: “It is almost inevitable that the perceived probability of ‘no deal’ will escalate over the coming weeks.”