It sounds odd for German companies to be in a “euphoric” mood while the euro has been on a tear higher, but there are solid factors behind that uplifted frame of mind, analysts say.
Concerns that a stronger euro will hurt big exporters in Europe’s largest economy have been reflected in the DAX 30 DAX, -0.34% The German stock benchmark slumped 1.7% last month, helping to drive down its year-to-date gain to about 6%.
However, “there are fundamental reasons why German industry is not too worried about the strengthening of the euro,” said Carsten Brzeski, chief economist at ING.
In July, German companies were “euphoric” about their prospects, the Ifo Institute for Economic Research said as it released results of its widely watched business climate survey, which hit a record level.
“German exporters are in high spirits,” Ifo wrote in a separate report. “The euro’s appreciation is obviously having no negative impact.”
That bullishness came even after a rise in the euro EURUSD, -0.3827% , which has charged up more than 12% against the U.S. dollar in 2017. It recently traded above $1.18, its strongest level in two-and-a-half years.
Euro strength can cut into the competitiveness of exported goods, as it can make them more expensive for overseas clients using other currencies to purchase and so lead to lower sales. As well, euro strength can eat into the profit made by multinational dollar earners.
Brzeski suggests there’s one key thing investors should remember when assessing the impact of strength in the shared currency on German companies’ stocks.
“The euro is still historically low,” the ING economist told MarketWatch. “There’s a pain threshold for German industry,” but “it’s still far, far off.”
That pain threshold against the greenback has typically been around $1.35, he said. The euro hasn’t traded there since July 2014. It is also well below its all-time high of $1.6040, which it hit in July 2008.
Credit Suisse at the end of last month noted the euro had been down about 12% against the dollar in terms of purchasing-power parity, a measure of valuing currencies.
Still, Credit Suisse expects the euro to rise to $1.22 on a 12-month basis, prompting its strategists to turn slightly less upbeat on European equities. They say they’ve pared their “overweight” rating on the region, but still support tilting portfolios toward Europe’s stocks.
Popular funds for betting on Germany include the iShares MSCI Germany ETF EWG, -0.49% , which has $5 billion in investor money, and the iShares Currency Hedged MSCI Germany ETF HEWG, -0.48% , which has about $800 million in assets under management.
The other thing to remember is that German goods land in other countries than the U.S. — and that means income in other currencies.
“When you want to get a proxy on the stronger exchange rate on all trading partners, you have to look at the trade-weighted exchange rate,” Brzeski said.
The “trade-weighted exchange rate” — also described as the nominal effective exchange rate — comes from measuring the euro against a basket of currencies of its major trading partners. The U.S. is Germany’s largest market for exports, with €106.9 billion worth of products shipped there in 2016, according to the Destatis statistics agency. France and the U.K. are next, in second and third place, respectively.
“The nominal effective exchange rate is only up about 5%,” Brzeski noted.
ING is seeing that companies are hedging their foreign-exchange risks, he said, “which means it’s going to take a while before much of the stronger exchange rate seeps into business.”
Companies in the Euro Stoxx 50 index SX5P, -0.55% — those where hedging information is specifically disclosed — say they are hedged at least 12 months out, according to Elga Bartsch, Morgan Stanley’s chief European economist.
But another 10% rise in the euro would cut earnings made by European companies by 5% to 8%, she said in a note Monday.
“Already in the current earnings season, we have seen the net balance of European companies beating their earnings estimates tracking at a modest 8%, compared to the 29% net beat in [the first quarter],” wrote Bartsch.
“Given that the euro has just put in the strongest three-month gain in over six years, a further weakening in European earnings momentum might lie ahead,” she said.
Morgan Stanley is assuming the euro will stand at $1.13 when companies report 2018 earnings, Bartsch noted, and that may be too conservative if the shared currency continues to push higher.
“According to our currency experts, their bull case of 1.28 for EURUSD looks increasingly likely,” she wrote.
What has been driving the euro rally? The shared currency has climbed as investors see improving conditions in the eurozone economy, even after a recent run of downbeat German economic data. There’s also been speculation the European Central Bank may be preparing to taper its bond-purchase program in 2018.
At the same time, the euro is benefiting from overall dollar weakness DXY, +0.19% . The greenback has slipped as investors query the prospects for higher inflation in the U.S. and what that may mean for the U.S. Federal Reserve’s plans for another interest-rate hike this year.
European companies during the second quarter dealt with an average euro-dollar exchange rate of around $1.11, compared with $1.0650 in the first quarter, said Gautam Batra, chief investment officer of Mediolanum Asset Management.
He told MarketWatch that Mediolanum’s analysis shows that despite the stronger euro, companies on the continent have revised their second-quarter earnings higher by an average of 1%, with the bank and automobile sectors leading the way. By comparison, earnings have been revised lower, on average, during second-quarter periods running back to 2013.
“What’s going on?” he said. “Actually, the level of the euro is not that significant when compared to two other factors, one of which is the GDP growth rate which is expected for the eurozone and global GDP growth. The second is the level of oil prices ... which haven’t really changed that much.”
The growth rate for Europe’s gross domestic product is by far the “biggest sensitivity” for industry — more important than the currency impact or indeed even the oil impact, he said.
“That explains why German manufacturers are making the statement they are making. They are seeing the benefits of global and European GDP growth,” he said. “Being exporters and party to global trade, they are seeing resilience and optimism in terms of their confidence.”
Motor vehicles are Germany’s main export, accounting for roughly 19% of goods shipped out of the country in 2016, Machinery and chemical products were the second and third biggest exports, at 14.1% and 8.9%, respectively.
Overall, German exports hit a record high last year, rising 1.2% to €1.21 trillion.
But the thing that would hurt the German economy would be an even more rapid rise in the exchange-rate, ING’s Brzeski said. If the euro drove quickly through $1.20, $1.25 or $1.30, its industry would start feeling a negative impact.
But the strength of the euro is not the whole story for German stocks — there are other potentially negative factors to keep in mind, analysts noted.
One thing to watch for is a swing in German business sentiment. Brzeski said he finds that the Ifo survey can lag events by about a month, so German companies may strike a more cautious tone in the August report.
Plus, German auto makers are under scrutiny by European Union regulators over allegations of collusion. Concerns about that sector have been weighing on the DAX as of late, noted Mediolanum’s Batra.
There’s also risk from a short-term slowdown in France’s economy — Germany’s second-largest export market — as French President Emmanuel Macron oversees structural reforms in his country, said Brzeski.
But it’s from outside Europe that a key threat could come — a shift in trade policy by the U.S., given President Donald Trump has spoken about the need to protect American business.
“If there’s a clear move by [Trump’s] administration towards protectionism that becomes effective immediately, that would have an impact on the second half of the year,” Brzeski said.