Euro’s Rapid Rise Signals Europe’s Recovery

Europe’s economic recovery remains on track with the upswing continuing to broaden across countries and sectors. European equity markets have returned over 20% this year in US dollar terms but only half of that in euro terms, with the index languishing just below May’s peak in local currency.

The rapid appreciation of the euro has weighed on sentiment, and the equity index, raising concerns that a strong domestic currency could dampen the macroeconomic momentum. "We believe these concerns are overdone. The strength of the euro predominantly reflects a more robust eurozone recovery than currency markets expected at the start of the year," Grace Peters, executive director and European equities strategist at JP Morgan, commented, thenationonline reported.

Indeed, consensus forecasts for eurozone GDP have risen significantly since January, from 1.4% to 2.1% currently. A loss of confidence in the strength of the Fed’s hiking cycle appears to have also manifested in further upwards pressure on the euro versus US dollar. When analyzing the effect of a stronger euro on corporate profitability, it is most relevant to consider the effective (or trade-weighted) euro; where price appreciation has been far less material and equates to only a few percentage points headwind to profitability.

"We continue to experience a cyclical recovery in Europe and believe the evidence is growing that structural change is also afoot. As such, share price weakness driven by currency strength, and recent geopolitical friction, are an opportunity for investors to buy into the region’s recovery."

Within the eurozone, "we now advocate exposure to the French CAC 40 index, having previously favored German equites (DAX and MDAX indices). The German equity market is Europe’s most global (with around 23% of revenues generated on home soil) and the weakness of the euro in recent years boosted companies export performance.

"The DAX is also highly concentrated (the largest five firms make up over 40% of the index’s market cap.) Assisted by effective labor market reforms, Germany’s earnings have advanced significantly over the past five years, despite economic turbulence on the continent."

However, now that Europe’s economic recovery is accelerating and broadening out, "we believe investors will be better rewarded for shifting exposure to France where we see the potential for greater earnings upside over the next 12 months, and optionality over reforms at the French and European level."

The earnings of the French CAC 40 index stand 20% below where they were in 2007. This contrasts with Germany’s DAX index where significant earnings growth leaves the index’s earnings-per-share 45% above pre-crisis peak.