(Bloomberg) — A rare show of investor confidence in European unity is boosting the region’s stocks and currency at the same time, but equities’ good fortune could take a hit if the euro keeps climbing toward a pain threshold seen around $1.30, according to a Bloomberg survey.
There is still some way before the single currency could reach the level that will pose a threat to the region’s earnings recovery, according to the majority of the 24 strategists and fund managers polled. However, the euro’s rally to a two-year high just shy of $1.20 this month has brought it back on the radar of equity traders.
European assets are getting a boost from the region’s unusually coordinated response to the pandemic and a nascent economic recovery. The euro has soared about 11% from its March low, while the Euro Stoxx 50 Index has recouped about two-thirds of its losses from the selloff through March. While it’s not at the top of investors’ list of worries, a continued strengthening of the euro could hamper the corporate profit rebound expected in 2021.
“Euro strength is like a party followed by a hangover for European equities: a positive event in the political sphere tends to boost simultaneously the currency and equities, but it is a matter of time before the effects start to be negative,” said Vincent Manuel, chief investment officer at CA Indosuez Wealth Management.
Of the 24 market participants in Bloomberg’s survey, half gave a precise level they see as a pain threshold for stocks. Estimates ranged from $1.20 for Brooks Macdonald Asset Management Ltd., CA Indosuez Wealth Group and Principal Global Advisors Ltd. to a high of $1.40 for Societe Generale SA, BNP Paribas SA and Nordea Investment Funds SA.
For many, the pace of the euro’s gains and the shape of the economic recovery are more important factors, rather than a specific level. They said that while a strengthening euro is a mechanical drag on equities, it could be offset by other market forces such as stimulus measures or improving PMI data.
The currency’s rally could also draw policy attention. Quantitative easing from the European Central Bank — which holds its next policy meeting on Sept. 10 — has helped keep the euro lower, in turn supporting the earnings of European exporters.
“The euro strength is a big problem for the European Central Bank as well, causing a de facto policy tightening,” said Edward Park, deputy chief investment officer at Brooks Macdonald Asset Management, highlighting $1.20 as a key level that was discussed by policy makers back in September 2017. “There will be quite a few questions at the next ECB meeting as to whether they want to see a patch of euro weakness.”
Should the euro keep gaining, sectors with a cost base in the single currency and a high proportion of revenue in dollars are likely to be hit the most. That includes aerospace, industrials, health care, autos and luxury goods. Equities relying on the domestic economy, such as banks, insurance, utilities, telecoms and real estate, may be more immune. Importers, such as retailers or small-caps, which tend to have higher domestic exposure, may also benefit.
At a country level, most respondents in the survey said they expect Germany to be hit the hardest by a stronger currency, as DAX Index members rely heavily on exports.
For now, an improving economic backdrop and nascent European solidarity — demonstrated by the issuance of joint fiscal stimulus — are supporting the region’s assets. Further inflows into stock funds could also help offset the impact of a stronger currency, with Bank of America Corp.’s latest survey showing the EU is the most preferred global equity region among fund managers.
Below are comments from some of the strategists and fund managers surveyed.
Ankit Gheedia, macro equity strategist at BNP Paribas SA:
“Another 10% rise in the euro and you get some impact on profit margin in a big way. But these are special times with significant revenue uncertainty, so currency doesn’t matter much in the short term. A real pain threshold would be $1.40.”
Esty Dwek, head of global macro at Natixis Investment Managers:
“Given how externally oriented the eurozone economy is, a too-strong euro can become a headwind for European equities. We see the pain level probably closer to 1.25 today.”
Jeremy Gatto, investment manager at Unigestion SA:
“It’s a headwind in theory but not a driver currently as the euro is rising with an improving macro backdrop. Stimulus, pandemic and sentiment are more powerful drivers.”
Kasper Elmgreen, head of equity investment at Amundi SA:
“The rising euro is a manageable headwind. The currency is up because European assets are in demand, so both the currency and equities can rise together.”
Max Kettner, multi-asset strategist at HSBC Holdings Plc:
“The cyclical nature of Eurozone equities and the high foreign revenue exposure make a higher EUR a significant headwind to EPS. There is no particular threshold level for euro area risk assets. It’s much more about the magnitude of the change in value of the euro against the dollar rather than the level. And what we see is that it is already having quite a detrimental impact on euro area EPS revisions, when we compare them to the U.S. If the EUR were to stay at these levels that would mean continued headwinds for euro area earnings for the next 6 months at least.”
Roland Kaloyan, head of European equity strategy at SocGen:
“A 10% strengthening of the euro would reduce European equity market earnings by 4%, all else equal. But keep in mind that on the other side of the equation there is the European region becoming stronger and more unity as we saw recently. You can then have a decrease in risk premium of European equities which translates into higher multiples and higher valuation.”
Rolf Ganter, head of European equities at UBS Wealth Management
“If the euro continues to rise, it is clearly a headwind, but right now nobody cares about that as we have bigger problems. We are not playing the currency play right now. That might come later, when the situation stabilizes, when we know if there is a vaccine and we can see clearer.”
Sean Darby, head of equity strategy at Jefferies LLC:
“The trade-weighted euro would need to appreciate by another 5 to 9% to make a significant difference and the rest of the world slow down at the same time.”“The recent appreciation of the euro has led to fears that Europe’s economic and earnings recovery will stutter. In our view, investors are missing one very real success story of the EU and that is the importance of intra-Europe trade,” he also wrote in a note on Aug. 24.
Sebastian Raedler, strategist at Bank of America:
“If PMIs continue rising, as we expect them to over the coming months, then equity markets will be able to rise even against the backdrop of a strengthening currency, given that the negative impact is offset by another powerful driver.”
Sharon Bell, strategist at Goldman Sachs Group Inc.:
“If the euro is rising versus the dollar because ALL currencies are rising versus dollar (like GBP, CHF, SEK) then in trade-weighted terms the pain is unlikely to be as bad.”“European equities are more sensitive to growth than to currency appreciation. The higher the euro and the swifter the increase, the more difficult it is for companies to adjust their FX exposure,” she also wrote in a note on July 31.
Emmanuel Cau, head of European equity strategy at Barclays Plc:
“We believe further euro strength, for the ‘right’ reason, should not be an impediment to Eurozone outperformance at this stage. It would indeed boost dollar returns for foreign-based investors, and likely drive more inflows in the region. However, it could challenge the strong year-to-date outperformance of exporters, and help the rotation to domestic plays.”
Sylvain Goyon, head of equity strategy at Oddo BHF:
“If the risk perception associated to the eurozone recedes, it has great chances to promote more inflows, which will be supportive for the European equities. So, it is perfectly possible to get rising European indexes with a stronger euro, as it had been the case between March 2002 and September 2007.”
Shoqat Bunglawala, head of Global Portfolio Solutions EMEA & APAC at Goldman Sachs Asset Management:
“A channel through which euro affects Eurozone equities is international earnings. We find an elasticity of -0.26 to the euro so that, all else equal, a 10% appreciation of the euro vs the dollar reduces euro area earnings by 2.6% in the contemporaneous year.”
Stephen Jen, CEO of Eurizon Slj Capital:
“The higher the euro, the heavier will inflation prints be in Europe, all else equal. The problem is that the ECB has very limited scope to ease further, and this forces the euro to adjust. The euro cannot go higher if it has to go lower to square the circle.”
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