European Markets: three themes

Tom Stubbe Olsen, Founder of Mensarius AG
and Portfolio Manager of Nordea Asset Management’s European Value strategy

Ongoing themes that have continued to weigh on European markets are tariffs and the escalating potential for a trade war, the turning tide of inflation and concerns around Italy’s fiscal stability.

Further escalation of potential trade war

The unstable situation between the US and its trading partners around the world has dominated headlines and impacted markets. Tariffs will result in higher input prices and put upward pressure on inflation.

One trend emerging through the noise is the return of price inflation. Commodity prices have been rising for some time now, companies have started to experience higher input prices and expectations of an increase in inflation have begun to be factored into the valuation of financial assets. How high inflation rates will go in the near future remains to be seen. But it is clear most companies now have to deal with a rise in raw material costs and wages – while the possibility of tariff hikes from a trade war would further inflate their input prices.

Importance of pricing power

When the tide of inflation turns, pricing power will be crucial to companies’ sustainable profitability and ability to produce strong earnings. Aggressive monetary policy had reduced the importance of pricing power, as multiple expansion has been a stronger driver of stock prices than earnings. As further multiple expansion seems unlikely in the presence of modestly rising interest rates, we firmly believe that pricing (and earning) power will be the main driver of future stock prices – and become all the more important if it has to offset some contraction of valuation multiples.

A modest inflationary environment is also positive for companies that possess pricing power, as prices have a positive effect on the top line, while maintaining or even expanding margins. Within various sectors and value chains, it will become apparent which companies can pass cost inflation through to defend their profit margins, and which will see profits come under pressure.

Italian government’s budget announcement

Italian stocks and bonds fell sharply on 28 September, as the country’s populist government announced its budget and fiscal targets for 2019. Investors are concerned about the country’s fiscal stability and its large debt as a percentage of GDP. Italy has the second largest debt in the Eurozone after Greece.

The Five Star Movement/League coalition that governs the country has pledged higher welfare spending and tax cuts. With these promises, the Italian government is widening the country’s budget deficit, bringing it closer to the EU’s limit of 3% of GDP. The target for 2019 is 2.4% of GDP (triple what the previous government had planned), suggesting the new Italian leaders intend to stick to the election promises that brought them to power. The announcement pushed the Italian 10Y government bond yield up from 2.8% to 3.3% (as of 02.10.2018), while the spread against German Bunds – which gauge the market appetite for Italian debt – soared from late September lows of around 2.3% to 2.9% (as of 02.10.2018). Together with the bonds, Italian banks and financials were some of the hardest hit. The Italian budget 2019 was sent for approval, but it got rejected by the European Commission on Tuesday 23 October. Italy has now three weeks to submit a revised budget, which the commission has to respond to within the following three weeks. This means that the budget dispute could go on until early December.

Italy is currently seen more as an idiosyncratic case. Nevertheless, with this move putting Italy, one of the Eurozone’s biggest government borrowers, on a collision course with the European Union, we cannot underestimate the impact it could have.

About Nordea Asset Management

Nordea Asset Management (NAM, AuM 213.4 bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 307 bn EUR*). NAM offers European and global investors’ exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Sao Paulo, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

 *Source: Nordea Investment Funds, S.A., 30.06.2018

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and representative offices are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and representative offices. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same, but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

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