Euro strength has emerged as the main talking point for the European Central Bank. Officials at this week's meeting described the euro, already up close to 4% versus the US dollar since the turn of the year, as a "downside risk" and a "source for uncertainty" that requires monitoring. With the ECB poised to start withdrawing stimulus, we believe the euro will rise further to USD 1.30 over 12 months. This will be a drag on Eurozone firms too, with a 10% trade-weighted rise in the currency typically translating into a 4% fall in profits.
Despite the headwind, we believe Eurozone stocks can go on rising, especially versus the UK market.
- The euro's appreciation has been mostly against the US dollar, with a smaller rise against other trading partners. On the Bank of England's trade-weighted measure, the euro is only up 0.3% this year, roughly one-tenth of its appreciation versus the USD. And just 13.7% of Eurozone exports go to the US.
- A strong global and Eurozone economy should cushion the blow to earnings. Data has been topping forecasts, with the Citi Economic Surprise Index for the Eurozone at 58, up from just 6.6 in August. We still anticipate earnings growth approaching 10% for 2018.
- The UK market, our underweight relative to Eurozone equities, is even more heavily dependent on foreign earnings, and the pound has strengthened more than the euro this year. Sterling is up 1.6% so far against the euro, and 5.6% since a recent trough in August.
So while Eurozone stocks may not be as celebrated in 2018, we think the outlook remains positive.
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