U.S. Stocks Ignoring `Underappreciated Risk' From Europe Slump


(Bloomberg) -- The soft spot for the global economy is a source of strength for the U.S. stock market -- and an under-the-radar threat to the rally as first-quarter earnings season looms.

A basket of American companies with outsized exposure to Europe is up 23 percent this year, outpacing the S&P 500 Index’s 15 percent advance and the 12 percent gain in European equities in dollar terms.

The situation is a transatlantic conundrum: the International Monetary Fund blames the continent for its softest global growth outlook since the financial crisis, while the Trump administration is readying tariffs on $11 billion in imports from the European Union.

Bloomberg Intelligence chief equity strategist Gina Martin Adams warns that Europe, not China, is the "underappreciated" risk for S&P 500 profits. Disclosed sales to Europe among index constituents dwarf those of China. Yet stocks with the most exposure to Europe have seen full-year earnings per share estimates cut by a "suspiciously limited" 2.1 percent since October, notes Adams, while profit projections for more Chinese-centric companies have been slashed by 8.1 percent over the same span.

The torrid run of form year-to-date reinforces the potential that meager activity in Europe -- should green shoots fail to bloom -- and heightened trade tensions could lead to a moment of reckoning in American stocks.

U.S. Stocks Ignoring `Underappreciated Risk' From Europe Slump

During the fourth-quarter risk rout, euro-tilted U.S. stocks lagged behind the S&P 500 by about 4.5 percentage points. The median stock in this Goldman Sachs Group Inc.’s list of 50 companies from the Russell 1000 generates roughly one-third of its revenues from the continent and 60 percent from outside the U.S.

“The U.S. equity market is generally failing to price in the extent of the global slowdown,’’ said Peter Cecchini, global chief market strategist at Cantor Fitzgerald. “We can see this divergence when looking at global rates versus the U.S. equity market.’’

Certainly, the German bund market does not suggest a high degree of underlying domestic vigor.

An escalation of U.S. tariffs to the automobile industry “would add insult to injury for a struggling euro zone economy that is just barely showing signs of stabilization,’’ Mazen Issa, a senior currency strategist at TD Securities, wrote. “Not only would this derail the prospects of a euro zone recovery, but it would likely to feedback into U.S. asset prices as well.’’

©2019 Bloomberg L.P.

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