About this episode
As the U.S. presidential election remains closely contested, our experts discuss what a change in administration could mean for European equities in terms of trade, China relations and other key issues. ----- Transcript ----- Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research. Marina Zavolock: And I'm Marina Zavolock, Chief European Equity Strategist. Michael Zezas: And on this episode of Thoughts on the Market, we'll discuss how the U.S. election could impact European markets. It's Wednesday, April 24th at 10am in New York. Marina Zavolock: And 3pm in London. Michael Zezas: As the U.S. presidential election gets closer and the outcome remains highly uncertain, we're exploring the impact of a potential departure from the current status quo of President Biden in the White House. Today, my colleague Marina and I want to discuss just what that would mean for European equity markets. Marina, how closely is Europe following the election, and why? Marina Zavolock: So, European equities derive about 25 percent of their market cap weighted revenues from the U.S. And the U.S. is the largest export market for European firms outside of Europe. So, of course, interest in U.S. elections here is very high; and this is in terms of the exposures of European stocks, sectors, asset classes, and economics as a whole. European investors, I would say that their peak interest in U.S. elections was around the Republican primaries, and it's stayed elevated ever since. And Mike, I know you want to dig in specifically on how European markets would react in a change in status quo scenario. But first let's talk about your outlook on some of the key policies that may change if Biden loses the election. What are your thoughts on trade policy and tariffs? Michael Zezas: Trump's been clear about his view that countries levying higher tariffs on U.S. imports than the US levies on their imports is unfair, and he's willing to correct it with tariffs. And while in his term as president he focused more on China, he was interested in tariff escalation with Europe. But he reportedly was moved off that position by advisors and members of his own party who were wary of creating more noise in the transatlantic alliance. But this time around, the Republican party's views are much more aligned with Trump's. So, imports on European goods like autos could easily come into scope. Marina, how are you thinking about the impact of potentially higher tariffs on the European market? What sectors might be most affected? Marina Zavolock: The initial reaction to recent tariff related headlines we've been fielding from investors is around the risks to our bullish European equities view in particular. The general investor feedback we get is that European equities may continue to rally for now, but as we approach November and as we approach US elections, the downside risks from this event start to build. What our in-depth analysis demonstrates, however, is that it's far more nuanced than that. As I mentioned, Europe derives about 25 per cent of its weighted revenues from the US. But, when we've dug into that number, most of these revenues are in the form of services or local to local goods, meaning goods produced locally in the US and sold in the US -- but by European companies. Only about 6 per cent of Europe's overall weighted revenue exposure is to goods exported into the US. So, we find the risk is far more idiosyncratic from a change in tariff policy than broad based. And in terms of individual sectors most exposed to tariff risks, these include a lot of healthcare sectors -- med tech, life sciences, pharma, biotech -- aerospace as well, metals and mining; of course, autos as you mentioned, and a number of others. After tariffs, the Inflation Reduction Act (IRA) is the next most common policy area we get asked about in Europe, given relatively high exposures for European utilities, construction materials, and the capital goods sector. Overall, we find European equities aggregate exposure to IRA is also low, is less than 2 percent of weighted revenues, so even lower than that of tariffs. But the stocks most exposed in Europe to IRA are underperforming the rest of the market. What are your scenarios around the IRA if Trump wins, Mike? Michael Zezas: Well, we think the money appropriated in the IRA is here to stay. Many of that program's investments overlap with geographies represented by Republicans in Congress, which means repealing the IRA may be a better talking point than a political strategy -- similar to how Republicans in 2017 failed to repeal the Affordable Care Act despite campaigning on that as a priority. But Trump could certainly slow the spending of that money through regulatory means such as ratcheting up the rules about how much of the materials involved have to be sourced from within the US. Now switching gears, Marina, you mentioned the performance of European stocks related to our election scenarios. Based on your recent work, you have very granular stock level data on relative exposure to potential administration policies. How are stocks with the greatest exposures behaving overall? Marina Zavolock: Yeah, this was a very interesting conclusion from our work. We thought that it's still fairly early ahead of US elections for stocks to start to diverge on the basis of potential policy changes. But what we found when we surveyed our analysts and collected data for over 350 European stocks with material US exposure is that when we break out these exposures and we aggregate them, the stocks with the highest level of potential risk exposure to Trump administration policies are underperforming the overall market. And the stocks with the greatest potential positive exposure, to Trump administration policies are outperforming. And then you have groups like moderate exposure that are in the middle, and these groups, no matter how we slice the data for different policies, are lining up. Exactly as you might expect, depending on their level of exposure as the market starts to price in some probability of either scenario coming through. We're also starting to see the volatility of the stocks most exposed start to rise. But this is a very early trend. The other big area that we get asked about is China. So, Europe has about 8 per cent of its weighted revenues exposed to China. It's the highest of any major developed market region in the world. What are your expectations about China policy under a new Trump administration? Michael Zezas: Well, it's bipartisan consensus now that China is a rival and that more protective barriers to trade are needed to protect the US' tech advantage in order to safeguard US national and economic security. But like with Europe, Trump appears more willing to use tariffs as a tool in this rivalry, which can create more rhetorical and fundamental noise in the economic relationship. Marina, how do you think this would impact Europe? Marina Zavolock: So, we've been talking about China as a risk factor for some time for a variety of reasons, and recently when I mentioned that European stocks are starting to react to potential change in administration policies. This hasn't so much been the case on China exposures. China exposures are behaving as they were before. We're not seeing any great divergences as we approach elections; though in our overall model, we do favor sectors with lower exposure to China. Mike, and how are you thinking about Ukraine? We have a huge amount of interest in the defense sector, and it's one of the best performing sectors in Europe this year. Michael Zezas: Yeah. So here Trump's been pretty clear that he'd like to push for a rapid reconciliation between Russia and Ukraine. What investors should pay attention to is that a Trump attempt at rapid reconciliation, perhaps in contrast with the European approach. And then when you couple that with potential tariffs on Europe from the US, it can send a signal to Europe that they have to shift their own defense and economic strategy. And one manifestation of that could be greater security spending, particularly defense spending in Europe and globally. It's a key reason why defense is a sector we favor in both the US and Europe. So, Marina, what are some of the bottom-line conclusions for investors? Marina Zavolock: I think there's two main conclusions from our work. First, the aggregate exposures in Europe to potential changes in policy from a Trump administration are pretty low and quite idiosyncratic by stock. We talked about a few of the greatest exposure areas, but in aggregate, if we take all the policy areas that we've analyzed, net exposure of Europe's revenues is about 7 per cent. Second, the stocks that are most exposed, either positively or negatively, are already moving based on those relative exposures, and we think that will continue, and these groups of stocks will also have increased volatility as we get closer to November. Michael Zezas: Marina, thanks for taking the time to talk. Marina Zavolock: Great speaking with you, Mike. 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