The euro devaluation is the main driver of euro zone equities’ rise

Posted on 01. Dec, 2015 by Jean Jacques Ohana in Weekly Focus | 0 comments

December 1, 2015

The effective euro currency rate dropped 13% since Mid-2014 (figure 1). The euro went into free fall not only vs. the dollar but also vs. the Chinese yuan, the Swiss franc and the British Pound.

This depreciation is a direct consequence of the ECB quantitative easing (and the subsequent euro zone bonds reflation). Furthermore, the euro’s drop has also helped euro zone exporters by increasing their competitiveness and profit margins. The euro decline has also a monetary effect on euro zone assets, making them more attractive to foreign investors.

From a financial point of view, as the EUR/USD has dropped 13% year to date, equities denominated in euro should appreciate compared to similar equities denominated in dollar, to compensate for the monetary debasement. This is exactly what happened as Euro Stoxx in USD has equally performed US S&P 500 in USD (figure 2). From a global macro point of view, the outperformance of Euro Stoxx vs. US S&P 500 reflects nothing more than the mere EUR/USD depreciation.

The acceleration of performance of a diversified portfolio in EUR (30% Euro Stoxx + 70% Bund) illustrates the consequences of this depreciation on the financial reflation of euro zone assets (figure 3). This portfolio was up 10% in 2014 and is up 4.8% in 2015. As a result, the euro currency has turned from a risky currency (related to euro zone risky sovereign bonds) into a funding currency, as low rates of funding are leveraged by investors to take risky positions on credit, equities and emerging currencies. The EUR/USD is presently negatively correlated to the Euro Stoxx, while they used to be positively correlated from 2009 to 2014 (figure 4). Every time risky assets undergo a correction, the euro rises as investors rush to the exit to cut risk and the associated financing positions.

The ECB meeting (to be held next Thursday 3rd December) may well reinforce the euro drop and then provide more fuel to European assets in the short term. However the euro decline (and the ECB support) does not immunize euro zone equities against global growth issues. The other countries will indeed not hesitate to devaluate in the face of gloomy global growth perspectives (think about a new round of yuan devaluation of China) and for the time being, prices of euro zone stocks have risen well ahead of lackluster earnings (figure 5).

 

Figure 1: Euro effective exchange rate vs. a basket of currencies weighted by their significance in the trade balance with the euro zone.

Figure 2: Euro Stoxx in USD (red), Euro Stoxx in EUR (white) and US S&P 500 (green) in USD in 2015.

 

Figure 3: Performance of euro zone domestic diversified portfolio (30% Euro Stoxx 50 + 70% Bund).


Figure 4: Correlations between the EUR/USD and Euro Stoxx, Commodities and AUD/USD.

Figure 5: Forward 12M earnings of Euro Stoxx 50 vs. spot price of Euro Stoxx 50.

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