Transcript

Stephan Kemper

Hello and welcome to another weekly podcast from BNP Paribas Wealth Management. I'm Stefan Kemper, Chief Investment Strategist, and today I'm joined by my colleague, Guy Ertz, our Deputy Global CIO. Hi Guy.

Guy Ertz

Hi.

Stephan Kemper

Today we are going to talk about the recent Europe-US trade deal and the impact on the economy and equity markets. The European Union and the United States have agreed on a deal that will see the EU face 15% tariffs on most of its exports, including, and that’s quite crucial, automobiles, pharmas and semiconductors. And it's going to avoid a trade war.

The 50% level on steel and aluminium, however, is maintained. In exchange, the EU would plan to import up to USD 700 billion worth of energy and invest another USD 600 billion in the US economy and purchase much more military equipment, probably not too surprising. The European Union would also bring down the tariffs to zero for many US goods.

So taking all this together, from your perspective, is it a good deal? And what do you think will be the impact on economic growth?

Guy Ertz

Well, of course the answer is not trivial, but on a net base, yes, we do think that this is a good deal. Why? Well, the main fear that we had and the market had was about an escalation in that trade conflict, a so-called “tit-for-tat” scenario, meaning that some countries putting some tariffs and then the others too, etc. and that could have led to really, really high levels of tariffs.

So in that sense here we have some clarity that is key for consumer confidence, for business confidence, and thus also will be supportive for growth. However, and that's of course the other side, we do still have to take into account that the 15% tariff for Europe, and if you take the recent deals for Japan, the UK and other countries, we are heading probably towards an average net tariff rate outside of our initial 10% to 15% range and probably closer to 20%.

And on top of it, this is much, much higher of course than the average net tariff before the Trump era. So yes, this will have a negative impact. But again, we think that the reduction of uncertainty and especially for Europe, the expenditure programmes in infrastructure, in military goods expenditures will largely more than compensate and have a net positive effect in the US. It's a bit trickier because of course somebody will have to pay for those tariffs. And we still assume that the negative effects will come with some delay and probably will be visible in the August and September period, and probably going on for a few more months from that negative angle, specifically for the US economy.

Stephan Kemper

Now, so bit of a mixed bag, but from my perspective, certainly better for Europe than what you could read in the press over the last 1 or 2 days. But, talking about who is going to pay for it, as you say, this is an additional cost. And rising costs are somewhat the textbook definition of inflation. And that leads me to the next point. From your perspective, what will the impact be on inflation, assuming there is one, and probably a bit more importantly, what do you think the Fed will do about it?

Guy Ertz

Yes, well, that's a very crucial point for financial markets, because of course the debate about higher inflation is also a debate about the potential for the Fed to be cutting rates. But let's step back for a minute and think what this discussion is about. Who is going to pay for it? I mean, the exporters from foreign, from non-US countries could be, of course, a force to reduce their price. But it's not really what we see here in the recent data. Then of course, the US companies in particular that also import quite a lot of goods would either have the option of passing on the cost increases to the final consumer, but that would mean higher inflation, higher CPI, higher consumer price inflation. Or they would be forced to actually have a negative impact on their margins. And it will be, of course, quite likely a bit of both. What will be the dominant effect is still a bit open, but we do think that the inflationary impact will be concentrated in a period of about 6 to 8 months starting from August. And that would then cool down. So it would be a temporary effect with no wage price dynamics kicking in, but really limited in time. However, we still have the issue about margins and the potential pressure on margins. And that is, of course, an important part, as such already for the market.

The other important factor I mentioned is what is the consequence of having at least temporary higher inflation for the US Fed? Well, the Fed is in a bit of a tricky situation. There are a number of arguments to seeing lower rates, because the level at this stage is relatively high, including in real terms. But again, the Fed knows that there is a likely temporary inflation effect. So we think that the Fed should be more comfortable by the end of this year to start cutting rates. We will probably have more clarity then, by late autumn about how things are evolving. And we would still be looking for two rate cuts this year and two rate cuts next year. But of course, there is a bit of an asymmetry here in terms of risk. And we have to be looking here precisely how inflation is evolving. So on the main inflation risk is clearly on the US side, we don't see inflation risks, neither related to the trade nor to other factors, for Europe. So the ECB as such is in a much more comfortable situation.

Now we or I spoke about the impact of inflation potentially on margins. And that is a nice way, of course, to look for some transition to a question to you Stephan about equities because equities are a lot about earnings and a lot about margins. So how do you see the impact of the recent trade deal between the EU and the US on the equity markets and the sectors in particular?

Stephan Kemper

Well, I think this is also a twofold answer. If we look at the US, as you mentioned, we have the view that the impact of the tariffs on the economy will just take time to arrive, to really come through. And probably the same is true for margins. As you said, right now, we see increasing evidence that margins will come under pressure in the US because companies will, at least to a certain extent, bear the cost coming from these higher tariffs. According to a recent survey by the New York Fed, half of the companies are absorbing at least 50% of the impact for now. So that is quite substantial.

And when we look at recent commentaries from companies like Hasbro or GM who were pointing exactly to this effect, I think there's more pressure to come. And falling margins are usually accompanied by falling valuations. So when we look at US markets where the valuations are back to very elevated levels, this just doesn't feel justified. We think the market is a little bit too complacent in this respect. And therefore we stick to our underweight view on the US equity market.

In Europe, however, there's a totally different side of the story. There we would indeed say that a key element of uncertainty has lifted, has gone. And that should allow the market to refocus on the positive macroeconomic tailwinds that we have and those are coming from defence spending, as you mentioned. Those are coming from the German infrastructure spending plan. We're talking about €500 billion there, but also from the recently launched initiative made for Europe, which is a German private sector initiative, with more than 60 companies involved. They have pledged to invest up to EUR 630 billion in the German economy until 2028. And just as a reference, EUR 100 billion of investments is equal to roughly 2% of German GDP. So those are quite substantial numbers.

And this is mixed with still interesting valuations, undemanding valuations. Europe is far from being expensive. So that is a very good, fertile soil for future outperformance. And therefore we recently confirmed our positive overweight rating for European equities, with the German MDAX still being one of our topics. Talking about sectors, a sector where you would assume that it could be a huge beneficiary is automobiles, a sector in which we carried an underweight rating for quite some time. As part of the underperformance that this sector experienced was indeed related to price shocks, cost shocks due to tariffs, uncertainty, etc. This has been lifted so you should expect (or you could expect, which is probably better to say) a bit of a relief rally.

But that hasn't really occurred because the main structural headwinds that the sector is facing, which is especially still huge competition from electric vehicles coming out of China, sluggish demand, so on and so forth, this isn't going away just because tariffs are a little bit lower (they are still six times as high as there have been a couple of months ago). So therefore for now we think that any relief in European carmakers is probably a good opportunity to reduce positions. And when we look at recent earnings and commentaries from a lot of German or European companies, car companies, this seems to confirm our rather cautious thesis. On pharma, however, we think that the resolution of sectoral tariffs, which was a huge threat and overhang for sentiment, should be a clear benefit for the sector and that this should allow the market to focus on the strong demographic tailwinds that the pharma sector still enjoys. And obviously also on the attractive valuations, there are some valuations, both against the overall market but also against the sector history are still looking quite cheap, quite attractive. Therefore we still reiterate our overweight rating here. And I think this these are probably the most impacted sectors for the time being.

Guy Ertz

Well great, very clear Stefan. Thank you very much to our audience listening to this podcast today, please like, share and subscribe to our series of podcasts. And for more information, please search on the web for BNP Paribas Wealth Management market strategy. Until then, thanks a lot and goodbye.