External Content are objects in an email (eg. pictures) that are not directly attached to the email, but that are downloaded from an external source once you open the email. In the email, there is only a link that will instruct your browser to display this external content. Some senders use this method to track if you have opened the particular email along with its external content. The "Deactivate external content in emails" setting prevents external content in incoming emails from being downloaded automatically when you open them.
If you deactivate external content, some emails may not look as they were designed by the sender, because the pictures are missing. This will, however, most likely only affect commercial emails, as this method is rarely used in private email conversations. You can activate the content of an individual email by clicking "Show all" above the email.
This setting is not applied to emails in your Spam-folder. External content is generally not shown for these emails.
If you forward an email whose external content is deactivated, the pictures in the email will be replaced by empty placeholder images.