Deutsche Bank: Five reasons the European rally could falter

That’s the view of analysts at Deutsche Bank who said on Tuesday they remain cautious about European equities heading into year-end.

Since the lows on November 9, the day after the presidential election, European stocks have risen about 3%, tracking moves in US markets amid hopes for fiscal stimulus there and lower regulation.

Economists at Deutsche say tax cuts and increased government spending could boost US GDP growth to above 3% in the second half of next year.

But the firm’s head of European equities, Sebastian Raedler, said that won’t necessarily translate into “meaningful upside” for the European market in the near term, and he offered five reasons why:

Italian referendum
Deutsche’s European economists now see a 60% probability of a “No” vote in the Italian referendum on December 4. Peripheral bond spreads have widened over the past week, but European equities have yet to react, Raedler notes. “As a consequence, peripheral spreads now point to 5% downside for European equities.”

Chinese capital flight intensifies
Deutsche’s currency analysts claim that Chinese capital flight is now as intense as it was in the second half of last year, “pointing to an increased risk of a disorderly Chinese FX devaluation, especially if the Fed hikes rates on December 14.”

Risk of lower oil
Oil prices have fallen by 17% from the mid-October peak, as the dollar has risen back above its January peak, Raedler says. Deutsche’s FX strategists predict the buck will fall a further 5%, which could translate into a sharp decline for crude, possibly to $ 30 a barrel from the current level of about $ 45. A decline below $ 40 “is likely to lead to renewed financial stress via widening US high-yield spreads,” argues Raedler.

Higher bond yields
Expectations for more government borrowing in the US have lifted bond yields there and dragged European rates up, too. According to Deutsche, that’s reduced the relative attractiveness of European stocks.

“The 40 basis point rise in European real bond yields since the end of October has already reduced the fair-value [price-earnings ratio] by 5%,” Raedler says. “If bond yields keep rising,this will put further pressure on equity and credit valuations.”

Trump tail risks
So far, the market has focused on the benign elements of Trump’s agenda, particularly the prospect for significant fiscal stimulus. But Raedler notes that there is a risk these plans will be watered down or delayed and that other “less helpful” policies, such as import tariffs will come to the fore.

• This article also appeared on WSJ City, a made-for-mobile app that combines the best of the Wall Street Journal and Financial News, tailored for an audience in the City of London. Download here

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