Why European Stocks Can Survive a Stronger Euro
The rise of the euro is weighing on stocks, but it’s a sign of the eurozone recovery
Up goes the euro, down go European stocks. Or do they?
To judge by the broad performance of the Stoxx Europe 600, that’s the case. After a promising start to the year, the index has faded since May as the euro has charged higher, and shares are now up just 3.2% for the year, in contrast with continued good economic news from the continent. But the headline is far from the full story.
The gain in the euro—up 13% against the U.S. dollar this year—is causing worries that it will hit profits earned abroad. But it is also boosting returns for non-European investors. In dollar terms, the Stoxx Europe 600 is up 16.5%, handily outpacing the 9.8% gain for the S&P 500.
But a stronger euro shouldn’t be the only story. Domestic demand is proving an important source of strength for the eurozone—even among its big exporters. For instance, Germany’s statistics office says domestic demand grew 1% in the second quarter from the first, although the drag from net trade reduced overall growth to 0.6%.
Europe’s economic outlook remains strong. Moody’s Wednesday lifted its forecast for 2017 growth to 2.1% and for 2018 to 1.9%, arguing that a rising euro shouldn’t derail a homegrown recovery. Recent sentiment surveys haven’t suggested that the euro is a drag. Despite the rise in the currency, forecasts of earnings growth have only moderated gently, with FactSet pegging 2017 growth for the Stoxx Europe 600 at 12.5% and 2018 at 8.2%.
And under the surface, some laggards are gaining. One reason for the euro’s rise is the expectation that the European Central Bank will gently wind down its extraordinary monetary policy. If that generates a steeper yield curve, it should be good news for financial companies. Eurozone banks, which UBS notes offer a good combination of cyclical exposure and domestic focus, are duly outpacing the broader index, with the euro Stoxx Banks index up 11.7%.
The speed and size of the euro’s gains in recent weeks are undoubtedly weighing on stocks. But if a big part of the currency’s rise is down to the brightening prospects for the eurozone, then investors’ worries about the exchange rate should prove to be overdone.