Thought of the day
24.07 - Can Eurozone stocks cope with a stronger euro?
The euro has put on a turn of speed. On a trade-weighted basis, the currency has reached its highest level since December 2014, up more than 5% this year. While this has been good news for Europeans set to vacation overseas, it has been less good for Eurozone equity markets. We estimate that the euro rally constitutes a drag of about two percentage points on earnings per share for Eurozone companies. The Euro Stoxx 50 is now down about 5% from its May peak, whereas the S&P 500 has continued to hit record highs.
But we believe the relative underperformance of Eurozone equities may be overdone, for three reasons:
- Although the euro has rallied sharply in recent months, the rise has been more modest year-on-year – only 2% on a trade-weighted basis in the first half of this year compared with the same period in 2016. This should limit any apparent drag on reported earnings.
- As a relatively open economy – with 50% of revenues generated outside the region – the Eurozone is benefiting from a synchronized upswing in global demand. The JP Morgan Global manufacturing PMI has risen to 52.6 from 50.4 over the last year. Stronger global demand for Eurozone goods and services should more than offset currency translation effects.
- Once companies have weathered the rise in the currency, profit margins have room to expand. Net profit margins are running at just over 7%, versus a 2007 peak of 9.1%. Scope remains for firms to benefit from operating leverage. In the past 20 years, each 1% rise in revenues has, on average, translated into a 2.9% rise in EPS.
So although the appreciation in the euro is a near-term headwind, we remain upbeat on Eurozone equities and expect EPS growth of 10–12% for 2017. We are overweight relative to UK stocks, which should be held back by recent weakness in commodity prices and the fading impact of the weaker pound.