How To Transform A Weak Euro Into A Strong Investment

How To Transform A Weak Euro Into A Strong Investment
Carl Hazeley

over 1 year ago4 mins

  • The euro’s 10% fall in value versus the US dollar this year should be a positive for the earnings of European companies and, by extension, their shares.

  • But historically, a falling euro has meant more bad than good for Europe, meaning the region’s shares have underperformed on average.

  • Still, companies which make more of their sales to the US and fewer to Europe have outperformed and could continue to – including those in the media, healthcare, and consumer staples industries.

The euro’s 10% fall in value versus the US dollar this year should be a positive for the earnings of European companies and, by extension, their shares.

But historically, a falling euro has meant more bad than good for Europe, meaning the region’s shares have underperformed on average.

Still, companies which make more of their sales to the US and fewer to Europe have outperformed and could continue to – including those in the media, healthcare, and consumer staples industries.

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The euro has collapsed 10% versus the US dollar this year, on the back of a weak economy, energy crises, and the Russian invasion. This, as the Federal Reserve’s aggressive interest rate-hiking campaign has given the US dollar a whole new lease on life. That brought the currencies level for the first time in 20 years last week, which could leave a trail of stock market winners (and losers…) in its wake.

What does the weak euro mean for company earnings?

Companies in Europe’s key stock market index, the STOXX 600, make 24% of their aggregate sales in North America.

STOXX 600 sales exposure. Source: Goldman Sachs.
STOXX 600 sales exposure. Source: Goldman Sachs.

And since those US dollar sales are worth more when converted back to a weak euro, its weakness should ultimately be a positive thing for the profits of those European companies, all else equal. In fact, Goldman Sachs estimates that every 10% fall in the euro versus the dollar adds about 2.5 percentage points to European company earnings.

What does this mean for stock prices?

Strangely enough, European stocks have historically outperformed when the value of the euro has risen, not fallen. That’s because investors tend to view it as a “risk-on” currency – essentially the opposite of a safe haven like the dollar. So when economic growth has slowed, this risk has outweighed the potential reward of improved company profits.

But there have been pockets of outperformance as the euro’s fallen in value this year: European companies with substantial US sales have outperformed domestically focused companies by more than 10%.

Source: Goldman Sachs.
Source: Goldman Sachs.

Shares of companies with a domestic focus typically fall alongside the euro: the currency’s falling value reflects a loss of confidence in the region’s economic growth, which will naturally have a knock-on effect on its companies’ fundamentals. Those that do more of their business outside Europe, on the other hand, have seen analysts increase their profit estimates for next year. A weaker euro will push up the cost of imported goods, but those that can partially offset it with higher-value overseas sales should be better positioned to improve on their bottom lines.

So what’s the opportunity here?

With the above in mind, it makes sense to up your holdings of European companies with large non-European revenue, and steer clear of those with largely domestic businesses.

On the latter point, the European travel and leisure and retail industries make about 60% of their sales on average to the region. And given that their costs – like fuel and buying in the latest fashions – tend to be dollar-denominated, they’ll feel the pinch from a weak euro more acutely than most. So if you’re adjusting your portfolio to benefit from currency swings, these sectors might be worth avoiding in the short term.

On the former, media, healthcare, and consumer staples (notably food and beverages, and tobacco) have the highest sales exposure to North America at 51%, 39%, and 31% of their totals respectively. They also have below-average domestic European sales exposure, ranging 26-29% (the average is 42%). There are countless exchange-traded funds (ETFs) that track these industries, and these low-cost ones (0.46% expense ratio) might be a good place to start: iShares STOXX Europe 600 Media UCITS (ticker: EXH6), iShares STOXX Europe 600 Food & Beverage UCITS ETF (EXH3), and iShares STOXX Europe 600 Health Care UCITS ETF (EXV4).

You might also be tempted to screen for individual companies with the highest sales exposure to the US and lowest to the eurozone. But buying and selling based on currency moves alone is risky: the fewer stocks there are in your basket of investments, the more impact the idiosyncrasies of an individual company can have on your portfolio (for worse as well as for better). And let’s face it, there are tons of idiosyncrasies beyond just its sales exposure to the US and eurozone that can drive a company’s share price.

That said, it wouldn’t hurt to screen any existing individual company stocks you’re invested in for exactly that, so you’re not taken by surprise when they announce their latest earnings updates. You might also decide you want to adjust the weighting of your investments based on what you discover.

Finding a company’s sales exposure is straightforward: just Google your company’s name followed by “investor relations” to find its corporate website, head to the firm’s latest annual report (probably under a section marked “filings”, “earnings releases”, or “annual reports”), and search for “geography” in the report. More often than not, you’ll find yourself looking at the company’s sales breakdown by region, if not country.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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