Head - EMEA Investment Strategy
March 30, 2018
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We outline three reasons why investors should not be overly concerned by the recent Euro strength
Exports make the largest contribution to overall GDP in the Euro area and continue to grow. At the end of 2017, exports of goods and services accounted for 47.9% of Euro area GDP, with same figure below 30% only two decades ago. Germany and Netherlands currently have the largest dependence on export related sectors, with 87% and 48% of GDP within their respective countries attributed to the exports of goods and services. Spain, Italy and France have a lower overall dependence on export sectors, with exports contributing 30-33% of their GDP.
The increase in export dependency in Europe has been driven by an overall increase in aggregate trade, as the Eurozone benefits from on-going expansion of economic activity globally, along with growth in foreign euro area demand. Overall aggregate trade has grown, with exports, imports and the overall net balance with non-Eurozone countries seeing consistent increases over the last decade.
The Euro-area runs a trade balance surplus with the rest of the world. The Euro area’s largest trade partners continue to be the United States and China. The Euro area runs a trade surplus with non-EU countries of €238 billion a year, of which the largest contributor is the US with a surplus of €108 billion. China currently remains Europe’s largest source of imports, whilst being the second largest source of exports.
The trade-weighted Euro has appreciated 10% and has strengthened 17% against the US dollar since the beginning of 2017. This had made Euro area exports relatively more expensive and less competitive, while giving companies the benefit of lower import costs.
This makes the Eurozone potentially vulnerable to both a sustained strong Euro and to a fall in the global trade environment. While these two factors have been factors dampening business sentiment in recent months, and while both need continued close monitoring, at this stage we do not think that either factor is going to derail the GDP and EPS growth outlook in the coming months.
There are three reasons why we would not be overly concerned by this Euro strength:
1. Our view over the coming months is that the Euro is likely to range-trade
2. While the recent strength in the Euro has seen export growth stabilise over the last year, net exports still remain at multi-decade highs, with exporters relatively un-impacted from the higher Euro environment
3. Historically Eurozone EPS growth has had a much stronger relationship with GDP growth than it has with movements in the Euro. The r-squared between the MSCI EMU total return and the Euro-Dollar exchange rate is historically insignificant.
Using a sample of Eurozone companies with the greatest revenue exposure to the Americas, there have been periods over the past 5 years when their performance correlates well with Euro weakness.
Between late 2013 and late 2016 these companies performed well, rising alongside a weak euro. However, the relationship broke down around the time of the US Presidential election, with these stocks performing strongly while the euro-dollar has strengthened significantly.
This emphasises that the stronger earnings outlook and GDP growth have been more powerful drivers of returns than the negative impact of a stronger currency. We also would not be overly concerned by the recent rise in global trade tensions. While the US has for now singled out China as the target for its trade protectionism, European exporters to the US could potentially benefit.