What tariffs will be imposed and on whom, will the war in Ukraine continue or is an (unjust) peace coming, is America facing a new economic crisis – while these questions are certainly concerning investors in American securities, across the Atlantic everything is in ‘rosy’ tones. Given that global stock markets are (mostly) balanced, financial analysts are increasingly pointing out the significant gap between European and American indices. While the S&P 500 has recorded a five percent decline in the two and a half months of this year, and the Nasdaq has plummeted nearly 10 percent, the European STOXX 600 has strengthened by almost seven percent. An even better result is recorded by the German DAX index, which is up as much as 14 percent.
The situation is even better on the Hong Kong Stock Exchange: the HSI index is up nearly 18 percent this year. The Shanghai Stock Exchange benchmark is slightly up by 0.5 percent, but that is also an excellent result compared to American stock markets. As is well known, Wall Street has been experiencing a major sell-off for three weeks now, which has lowered the prices of the most popular issues by a third. The Nasdaq, an index packed with technology stocks, has melted down by 14 percent compared to its peak value of 20,100 points from mid-December, thus being deeply in a correction phase defined as a decline of at least 10 percent. The S&P 500, according to the closing value from Tuesday, is on the verge of entering a correction.
Melted Value of Japan
After a massive sell-off of American stocks on Monday, the market capitalization of companies in the S&P 500 has melted by a staggering four trillion dollars compared to its record value in February. For illustration, this is approximately the value of the entire Japanese economy. That the situation is serious is evidenced by the data from Goldman Sachs that hedge fund exposure to stocks is at its lowest since the outbreak of the coronavirus pandemic in early 2020. Despite the fierce sell-off, American stocks are still quite expensive. Last Friday, the price-to-earnings ratio of the S&P 500 index was 21, while the long-term average is just under 16, according to LSEG Datastream data.
Not only stocks have suffered; due to increasing doubts about the strength of the American economy, yields on U.S. bonds have fallen, and the dollar has weakened. The latest blow to the American market came on Tuesday from analysts at the British bank HSBC. They downgraded the outlook for American stocks to ‘neutral’ and raised expectations for European stocks. However, it should be emphasized that they pointed out that this does not mean that American stocks are no longer a good opportunity, but that European stocks can currently offer better returns.
Some American analysts consider this jump in European stock prices to be unfounded, primarily because the trade war initiated by the Trump administration will have even worse consequences for European companies than for American ones. One of the more well-known pessimists among American analysts, Marko Kolanović, in his LinkedIn posts emphasizes that it is illogical for European stocks to benefit from every scenario; the introduction of tariffs, their suspension, further war in Ukraine, or the arrival of a ceasefire. In this context, it is worth mentioning that European indices rose (after noon, the STOXX 600 by 1.1, and the DAX by as much as 1.8 percent) on Wednesday after news that the European Commission responded with tariffs to American tariffs on steel and aluminum.
Fundamentals Are Being Ignored
Marin Onorato, a partner at the investment fund management company Mathematica Capital Partners and a columnist for Lider, believes that tariffs will certainly harm both American and European companies, but investors in European stocks were practically prepared for tariffs when Trump won the elections, and this was likely already factored into stock prices. – Stock index prices have been very volatile in the last month, so I wouldn’t give too much importance to daily shifts. Sentiment in America is currently very negative while in Europe it is extremely positive, so all news should be viewed through that lens. Sometimes sentiment is so positive that fundamental factors are ignored, but this generally has a very finite lifespan – assesses Onorato.
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What then underlies such optimism in European markets? Onorato states that there are several reasons for the huge divergence of stock indices in the U.S. and Europe. – The first is the sentiment that was very negative for Europe and positive in the U.S., and most investors were heavily exposed to America compared to Europe. As early as the beginning of the year, Larry Fink, the head of BlackRock, said that Europe is ‘cheap’ and that one should slowly shift from more expensive American stocks to European securities. Furthermore, at the beginning of the year, Donald Trump announced the end of the war between Russia and Ukraine, which was a positive signal for European companies. Thirdly, European politics has become involved with plans to invest in European defense, infrastructure, and significant borrowing to stimulate economic growth in the EU, which was actually initiated by Trump himself. These three arguments have been a perfect tailwind for such superior performance of the DAX and other European stock indices, which are indeed valuation-wise cheaper than American stocks – emphasizes Onorato.
Another good indicator of sentiment is the interest rate differential between the U.S. and Germany, which has dramatically decreased in the last 45 days, adds this analyst. – On one side, you have an economic slowdown and less government spending, while in Europe, the (expected) story is now the opposite – says Onorato.
Tectonic Shift
Renowned economic analyst Mohamed El-Erian in a column for the Financial Times cites three reasons for the dramatic shift in investor perception regarding American stocks and their European and Chinese counterparts. The first is the growing concern for the future state of the American economy. When it comes to ‘American’ reasons, some analysts believe that this is not just about the macroeconomic state, but a tectonic shift in the American treatment of partners and allies. The perception of the U.S. as a reliable trading partner is now a thing of the past. Additionally, the Trump administration, as part of austerity measures, announced a drastic reduction in government incentives to the economy. Recently, Treasury Secretary Scott Bessent stated that the American economy will undergo a ‘detox period’, or withdrawal from government money.
If viewed this way, the current decline in American stocks may not just be a mere, healthy correction of inflated prices. It may be a complete paradigm shift in the business operations of American companies that will undoubtedly be painful without the injection of government money.
– If Trump and his cabinet continue to cut government spending, it will certainly have a significant impact on the economy and consequently on financial markets, which we also wrote about in the last column. America has accustomed consumers to massive spending in recent years, and now the withdrawal is very difficult. That question remains, only how persistent Trump will be in his plans as it will become increasingly difficult for voters. I do not have the answer to that question, and I think neither does the President of the United States – says Onorato.
Chinese Response
Along with the release of the debt brake, El-Erian believes that investors believe that China will respond to the American tariff blow, as well as to its internal economic problems, with more targeted policies. These hopes are grounded in news from early March when the Congress of the Communist Party was held. Additional fiscal incentives were announced there to stimulate personal consumption and mitigate the impact of American tariffs. Recall that the Trump administration imposed an additional 10 percent tariff on imports of Chinese goods, and Chinese companies export goods worth 400 billion dollars to that market. With an expected economic growth of five percent this year, the Chinese government also plans a budget deficit of four percent. The central government intends to borrow 179 billion dollars in the long term.
Personal consumption in China has lagged behind Western standards for many years, but it is also a cause of economic imbalances. Household consumption accounts for less than 40 percent of the economy’s value, which is even 20 percentage points lower than the global average. On the other hand, Chinese investments are more than 20 percentage points above the world average. For further capital strengthening of the largest state banks, more than 70 billion dollars will be allocated.
The grass on the stock exchange is clearly greener outside Wall Street. For now.
