More conciliatory comments from the US administration on US–China trade have helped equity markets recover part of their recent sharp losses. Larry Kudlow, Director of the US National Economic Council, said that President Donald Trump is planning a trip to China in September and is willing to negotiate. The S&P 500 gained 1.3% on Tuesday and the positive tone carried over into European hours on Wednesday, with the Stoxx Europe 600 rising 1% in morning trade.
The pattern of harsh rhetoric being followed by more optimistic comments is likely to keep equity markets volatile. But the economic data shows that behind the swings in sentiment, the ongoing US–China dispute continues to undermine manufacturing activity, particularly in countries heavily exposed to global trade, like Germany.
- One of the main channels for trade uncertainty to weigh on economic growth is through its negative impact on business confidence and investment, which in turn is reflected in weaker demand for capital goods. Official data released on Wednesday showed that German industrial production fell 1.5% month-on-month in June, a much steeper decline than expected, driven by declines in machinery, metals and auto production.
- Earlier in the week, data showed that German industrial orders jumped 2.5% m-o-m in June, more than reversing a 2% decline the previous month, driven by demand from outside the Eurozone. But orders were still 3.6% lower than June 2018 and core orders were down 0.4% m-o-m as some big ticket items drove the headline number higher. The data also covered the period prior to the latest escalation in trade tensions.
- Forward-looking survey data still points to an ongoing contraction in German manufacturing – the Markit manufacturing PMI was 43.2 in July, and has been below the 50 level, denoting a contraction, since January.
With a near-term resolution to the trade dispute appearing unlikely, pressure on business confidence and investment looks set to continue, which will have a knock-on effect on the German economy. Within international developed market stocks, we recommend an underweight to Eurozone equities, where market gains have outpaced economic fundamentals. Even after the most recent sell-off Eurozone equities are not cheap, trading on a 12-month forward price/earnings ratio of 12.7x, which is 2% above the 10-year average.
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