French political uncertainty and an EU trade spat with China are casting a shadow over European corporate earnings, investors say, despite forecasts that companies are set to deliver better results.

Second-quarter earnings for companies in the pan-European STOXX 600 are seen rising 2% and revenues increasing by 1.7%, LSEG I/B/E/S data shows, in what would be the first quarter of growth since the first three months of 2023.

Investors had been warming to Europe's equity markets as the European Central Bank embarked on looser policy and the economic outlook improved, but French President Emmanuel Macron's shock decision to call parliamentary elections has sparked doubts.

Concerns about France's fiscal discipline under new right- or left-wing governments have shaken confidence, as have fears of tax and minimum wage rises under the left.

Analysts have responded by trimming earnings expectations for French blue-chip firms and reining in expectations for European shares in the last two weeks.

The STOXX 600 index, which touched a record high on June 7, the last trading day before Macron dissolved parliament, is down 2.5% from that peak. France's CAC 40, at its lowest since January, has borne the brunt of the selling.

"It could be the typical seasonal pattern where you get some downgrades going into earnings season, but you're not getting as positive a signal as you got last quarter," said Citigroup European equity strategist David Groman.

"You have all these political risks coming to the fore, even as the fundamental story had been looking pretty strong," he said.

Results season kicks off in earnest from mid-July, with Barry Callebaut releasing results on July 11, Richemont on July 16 and ABB (ST:ABB) on July 18.

Last week, Nike (NYSE:NKE)'s worse-than-expected 2024 outlook and H&M (ST:HMb)'s downbeat trading update knocked confidence in consumer demand.

UNCERTAINTY

On Sunday, Marine Le Pen's far-right National Rally (RN) party won the first round of French parliamentary elections, a huge setback for Macron, although analysts noted the party won a smaller share of the vote than some polls had projected.

"Up until the European election, we think the European market was getting a bit more interest from global investors," said Steffen Weyl, euro-area fund head at Union Investment.

Redemptions from French equity funds hit a four-week high in the latest week, data from fund flow data provider EPFR showed.

Political risks were driving outflows from European funds, Citi's Groman said, adding: "The French election is a key flashpoint."

"I wouldn't be surprised if European companies started acknowledging that it's been a general source of uncertainty and would expect equities to be sensitive to these political risks."

Political risks are a key reason why Citigroup recently downgraded continental European stocks to neutral in its global equity strategy.

Markets are likely most fearful of a possible victory for the leftwing New Popular Front (NFP) alliance, Weyl said.

"It's much more unstable because you have so many different parties in there, from Greens to the ultra-left and the centre."

An NFP victory would also likely increase labour costs for French firms, noted Gilles Guibout, head of European equity strategies at AXA Investment Managers.

The NFP promises to raise the minimum wage by 14%.

OUTLOOK

As the broader European market trades near all-time highs, investors are looking for reassurance from the companies which were optimistic at the start of 2024.

"A lot of the anecdotal evidence ... is that companies are clinging to their guidance and still have a positive view towards H2," said Mark Schumann, head of European large-cap mutual funds at DWS Group.

"Now with a lot higher altitude in terms of the index levels, the market is getting increasingly nervous about getting some tangible evidence when it comes to these H2 outlooks."

The euro area's growth indicators are mixed.

While there had been signs that the contraction in the euro zone's manufacturing activity might have hit a trough, Citi's economic surprise index, which measures how economic data performs versus expectations, dropped into negative territory for the first time since January.

And the closely watched Ifo Institute survey showed German business morale fell unexpectedly in June, underlying concerns about recovery in the euro area's largest economy.

TRADE

Escalating trade tensions between the European Union and China are also clouding the picture.

Brussels proposed hefty duties on imports of Chinese-made electric vehicles to combat excessive subsidies which has unleashed countermeasures from Beijing, which launched a dumping probe into EU pork imports.

"Longer term it's a big problem for Germany as they're the big exporting economy within Europe," said Nathan Sweeney, CIO of multiasset at Marlborough.

Sweeney highlighted German autos and industrials as sectors to monitor.

Mathieu Savary, chief European investment strategist at BCA Research said he would like companies to recognise the heightened uncertainty.

"There is risk around the EU's relationship with China, which is clearly souring," Savary said.

"Acknowledging the political risk could be positive as it decreases the risk of disappointment in Q3 and Q4 earnings, when we might see the impact of political uncertainty on activity and the impact of the tensions with China."

Source : Economy News by Reuters - Jul 1, 2024