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(Bloomberg) — European stocks face a series of hurdles to extend their 2024 rally after hitting another record high this week.

Money managers at Goldman Sachs Group Inc., BlackRock Inc. and Northern Trust Asset Management warn investors should be prepared for mounting risks from the region’s lackluster economy and its impact on corporate earnings. The US elections are adding an extra layer of uncertainty.

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Markets are bracing for a volatile final quarter as a seemingly unstoppable rally in the first half has shifted into fluctuations of peaks and troughs over the past three months. And while China’s long-awaited stimulus measures could provide new momentum, the bar is high for equities to post meaningful gains.

Stocks are “sensitive at the moment,” said Helen Jewell, chief investment officer of fundamental equities for Europe, Middle East and Africa at BlackRock. “The US election is incredibly difficult to call, and you’ve got uncertainty around the macro outlook. This fragile market is going to continue until we get visibility into 2025.”

A weak economic backdrop in Europe contrasts sharply with the region’s equity benchmark at an all-time high. While fears of a global recession have eased as investors grow more confident about US growth, private-sector activity in the euro area shrank this month and forecasts indicate a looming contraction in Germany.

This week, Northern Trust cut its European allocation to neutral from overweight, citing the worrying macro outlook.

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“The economic data is looking quite shaky,” Anwiti Bahuguna, chief investment officer of global allocation at the $1.2-trillion asset manager, told Bloomberg TV. “Inflation is coming down, but not fast enough to think there would be very sharp relief on the rates front. It’s not a place to take a lot of risk.”

Earnings Risk

Third-quarter earnings, set to kick off in mid-October, will be crucial for assessing the impact of weaker growth on consumer demand. 

In an early sign of how the season could unfold, a JPMorgan Chase & Co. analyst warned that Novo Nordisk A/S’s quarterly earnings could show slower-than-expected sales of its blockbuster weight-loss drug Wegovy. Investors are also second-guessing wagers on retailers after Sweden’s Hennes & Mauritz AB said it’s unlikely to meet a key profit target for the year.

Expectations for full-year earnings have declined about 2.8% since January, according to data compiled by Bloomberg Intelligence. Still, some investors say even these estimates are too high, setting the stage for further downgrades.

“Our fund’s positioning is not very aggressive,” said Nicolas Simar, senior equity fund manager at Goldman Sachs Asset Management. “Short term, there’s little room for profits to improve substantially.”

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Simar specifically warned about the outlook for consumer goods companies, which have been impacted by declining demand in key markets like China. 

Election Gamble

The US presidential election could have a major impact on European earnings if Donald Trump clinches the vote. 

The Republican candidate has proposed a 10% across-the-board import tariff and steeper levies on Chinese-made goods. If this leads to a “full-blown trade war” and result in a “high single-digit drag” on regional earnings growth, Barclays strategists have said. 

German and Italian stocks, as well as sectors for capital goods, autos, beverages, technology and chemicals look most at risk, they said.

Political upheaval in France is also weighing on the region’s equities, with Paris underperforming major peers this year as investors are losing faith in the new government’s ability to survive.

The regional benchmark faces a test on technical indicators, too. Previous record highs have proved to be major points of resistance, with the index failing to rise above that level on four occasions since May. 

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China Effect

The slate of stimulus measures in China may be just what the Stoxx 600 needs to kick-start its year-end rally as companies generate about 8% in revenue from the Asian country.

Market strategists at Barclays and Citigroup Inc. said China’s steps brighten the outlook for so-called cyclical stocks — miners, automakers and discretionary consumer spending — which had lagged behind defensives for much of the third quarter. A basket tracking European cyclical stocks surged 3.2% this week, while the defensives gauge remained flat.

Even so, past promises of a recovery in China have been underwhelming as stimulus pledges failed to deliver a meaningful upturn. While the latest measures are likely to have a prolonged impact on local assets, the effect on the Chinese consumer down the line is questionable, according to Northern Trust’s Bahuguna. 

That also makes the outlook for Europe’s luxury-goods makers more cloudy. The sector — which relies on China for up to a fifth of revenue — has suffered as the downturn pushed shoppers to discount brands, and even the latest stimulus measures may be unlikely to reverse that for now.

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Meanwhile, automakers are trying to climb out of a deep hole, with the Stoxx 600 Automobiles & Parts Index rallying the most since November this week. It remains the second-worst performing sector in Europe this year, only behind energy and partly plagued by Europe’s trade tensions with China over electric vehicles.

Gilles Guibout, head of European equities at Axa IM in Paris, said the impact from China’s latest measures remains to be seen.

“It’s still too early to say right now,” he said. “But at the end of the day, the upcoming earnings will set the market trend moving forward.”

—With assistance from Christian Dass.

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