Volatility, Europe & Your Investments

Clearly, much of the current discussion about stock market volatility centers on factors at work in the North American stock markets.

Not surprisingly, much analysis examines made-in-the-USA factors such as whether or not the Federal Reserve (the ‘Fed’) will raise interest rates again, and if so how many times, by how much and when the rises will occur. A more or less equal amount of attention focuses on problems with the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google/Alphabet).

However, global geopolitical and macroeconomic factors, such as BREXIT and the slowing of both the European economy and the Chinese economy also affect the equation. In this article I review the effect of the European slowing and in future will examine the impact of China and other emerging markets.

In general, as the second largest economic bloc behind the United States, Europe and its economic activity have a major effect on American markets, increasing their volatility, either directly, through reduced earnings and revenues, or indirectly due to the movement of currencies against the US dollar, suggests Gavin Graham, media commentator, financial analyst and my co-author on two books about frontier markets.

Although the net effect on American companies has not crystallized, some impact appears inevitable. Since the United States is the European Union’s largest trading partner, the slowdown will hurt American companies’ earnings, especially those with large export operations involving Eurozone markets, Graham explains.

The uncertainty of BREXIT and the equally uncertain future of Prime Minister Theresa May and her government in the United Kingdom will have an impact but perhaps not as serious as sometimes predicted.

Still, even suggesting a timeline for resolution defies coherent analysis. With uncharacteristic hyperbole, The Economist called May’s BREXIT defeat in the British Parliament ‘the mother of all messes’ and ‘the hopeless mess’. The magazine sees a second referendum as inevitable and, as distasteful as it might seem for May, she will have to work mightily to find a different outcome.

If the BREXIT divorce proceeds on schedule on March 29, without an agreed-upon deal in place, there will be short-term disruption which could worsen the European slowdown. A deal between the European Union and the United Kingdom in the meantime would lessen the impact, Graham suggests.

Moreover, with the US Federal Reserve tightening its monetary policy throughout 2017 and 2018, through raising interest rates and withdrawing quantitative easing, while the European Central Bank just stopped easing at the end of 2018, the strength of the American greenback contributed to increased volatility.

The stocks of auto companies and their suppliers have become an exposed category. Given Germany’s status as Europe’s largest economy, and its dependence on exports, its slowdown will have negative effects on the rest of Europe. Graham points out that with auto sales, including Chinese sales, down sharply in 2018, Germany’s major industrial sector has begun contracting. The machinery and chemicals sectors are slowing and these factors also mean increasing volatility.

Dealing with these factors in investment portfolios means looking to defensive sectors with major domestic exposure, such as consumer products, food retailers, utilities and pipelines which have been less volatile than other sectors, Graham explains. Meanwhile sectors with major export exposure and overseas operations, such as auto manufacturing, capital equipment, technology and aerospace are most vulnerable and have been more volatile recently.