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Obscure outlook
The stock market decline accelerated in early April when President Trump announced high import tariffs on most trading partners. Although the market has recovered somewhat from the worst of the decline, the future outlook is still quite uncertain. The silver lining of the current situation is that the market has already priced in a clear weakening of economic growth. We recommend that investors keep equity and fixed income investments in neutral weight in their portfolios. Patience, keeping the portfolio invested and good portfolio diversification are the best tools for investors during market turbulence.
Tariffs weigh on the economy and markets
In early April, the US administration announced a 10% general tariff on all imports, as well as hefty reciprocal tariffs on many countries. However, President Trump suspended these tariffs for 90 days, except for China, after the stock market experienced a sharp decline. During the pause, the US is seeking to hold trade negotiations with its trading partners. Trump has also hinted that if trade negotiations go well, the additional tariffs will not take effect. For China, tariffs were raised to as much as 145%. However, some goods imported from China, such as smartphones, are exempt from the highest additional tariffs. The US is also seeking to negotiate with China, but negotiations have not yet begun.
The tariffs collected by the United States are likely to be lower than what Trump announced initially, but higher than what markets expected at the beginning of Trump's term. The final outcome of the tariffs and trade negotiations is difficult to predict, but it is likely that both economic and earnings growth will be considerably lower this year than previously estimated. There is currently great uncertainty about the tariffs and their impact, and the US economy in particular is suffering.
Global equities have fallen by around five percent in April as a result of market volatility. Since the beginning of the year, the stock market performance is -10 percent. Of the equity regions, North America (-6%) and China (-10%) have developed the weakest in April. The return of the Helsinki Stock Exchange's weighted CAP index in April is zero. And since the beginning of the year, the Helsinki Stock Exchange's returns are comfortably up six percent.
IMF lowered growth forecasts
The International Monetary Fund (IMF) has lowered its global growth forecast due to the negative effects of the trade war. The IMF expects global economic growth to slow to 2.8 percent this year from 3.3 percent last year. At the beginning of the year, the growth rate was expected to remain unchanged. However, the IMF does not expect a recession, but considers the growth outlook still to be moderate.
The US growth forecast for this year was lowered to 1.8 percent, compared to 2.7 percent growth expected in January. At the same time, the US inflation forecast for this year was raised by one percentage point to three percent. The second largest forecast cut was for China, whose growth forecast for this year was lowered by 0.6 percentage points to 4.0 percent.
The euro area growth forecast was lowered by only 0.2 percentage points to 0.8 percent, as fiscal stimulus offset some of the effects of tariffs. Next year, economic growth in the euro area is expected to accelerate to 1.2%, thanks to growth in the big three: Germany, Italy and France.
Earnings expectations decline
Last year, corporate earnings grew by 10 percent for global equities, which was quite a strong development. At the start of this year, earnings were expected to grow by 12 percent this year, and growth was also expected to occur on a broad front, both in terms of equity regions and sectors. However, uncertainty related to the trade war has turned earnings growth expectations downward. Earnings are currently expected to grow by nine percent this year, but growth expectations will likely be cut further. Companies and analysts who follow companies are still cautious with their forecasts, as the prolonged trade negotiations continue the period of uncertainty. Among major markets, the earnings expectation for US equities was close to 15 percent at the beginning of the year. Currently, the expectation has already been reduced to nine percent.
The earnings expectation for the Helsinki Stock Exchange for this year was at best 15 percent. Now the expectation has dropped to around 10 percent. Trade-related uncertainty is weighing on investment demand, so a prolonged trade war could well weigh on the prospects of cyclical companies in Helsinki. Business confidence fell in April in both the United States and Europe. However, the decline was not drastic, so based on the companies' outlook, economic activity will slow down somewhat, but a recession would be avoided.
As a result of the decline in share prices, valuation multiples in the stock market have decreased. The P/E ratio for international shares is currently 17. Before the decline in share prices, the valuation multiple was at its highest at 19, and during the tariff shock in early April, the P/E ratio was below 16. The historical average of the P/E ratio is 16. There is currently uncertainty surrounding stock valuation multiples, as companies' earnings estimates for the coming quarters are still a question mark.
Raise European equities to overweight
We lift European equities to overweight in our regional equity recommendations. Easing fiscal policy, investments, lower interest rates and easing EU-level regulation support the region's earnings growth prospects and also support higher valuation multiples. Of course, the risk is that the policy change will again be less than expected. We downgrade Japanese equities to underweight in our recommendations.
We downgrade industrials to underweight in our sector recommendations due to tariff concerns. Correspondingly, we reduce the underweight in consumer staples. The financial sector, which will continue to benefit from moderate economic growth and still high interest rates, remains overweight in the recommendations.
Interest rates fell in April
Eurozone government yields fell slightly in April. Weaker growth prospects and stock market volatility have supported demand for government bonds and pushed interest rates lower. In addition, the European Central Bank (ECB) cut its key interest rate at its April policy meeting. Markets expect interest rate cuts to continue. The ECB is currently focusing on economic growth risks. The uncertainty created by tariffs is likely to weigh on the growth outlook in the eurozone as well, according to the ECB's estimates.
As a result of the growth uncertainty caused by the trade war, companies' credit spreads have widened slightly. If at the beginning of the year, margins were at historic lows, they are now close to thirtieth percentile of the historic distribution, i.e. still quite low. Although growth has slowed slightly, companies' creditworthiness is expected to remain fairly stable. Naturally, a clear weakening of growth would shift default expectations upwards. However, the number of defaults for high-yield corporate bonds is currently still low. In turbulent times like experienced in early April, companies' access to financial markets is very challenging. A significant tightening in financing conditions would be particularly harmful for companies with the highest credit risk.
Bond yields continue to offer interesting investment opportunities. Euribor rates have fallen quite rapidly, so interest rates will be lower on deposits in the future. As for fixed income investments, investors should therefore shift their focus on the bond market. In Nordea's house view, we recommend an overweight in eurozone investment grade corporate bonds and an underweight in eurozone government bonds in the fixed income portfolio. US investment grade bonds are downgraded to neutral weight. The economic outlook for the eurozone is currently assessed as more stable than that of the United States. Investors should remember to diversify their investments well also in their fixed income portfolio.
