Euro Still Too Expensive Versus Dollar, Expect Parity
Financial headlines have a tendency to fixate on one shiny object after another. In the summer of 2013 the topic du jour was the debt ceiling. Then it became the looming threat of widespread European defaults. Now, as you are no doubt painfully aware, the spotlight is shining brightly on the ‘fiscal cliff,’ a series of federal spending cuts and tax increases set to take effect on January 2, barring a last-minute political compromise.
Despite the incessant handwringing, we expect leaders from both parties will eventually get a deal done. Politicians have a way of patching together agreements on important issues once they see their political lives flash before them, even if it typically comes after a period of prolonged procrastination.
Assuming a solution to the fiscal cliff is reached, what then is the next ‘shiny object’ that will capture the attention of the media, international politicians and the investing public? To us, it’s the over-valuation of the European Union’s common currency. The euro is the biggest factor preventing an economic recovery across the pond, exceeding even the indebtedness of Portugal, Italy, Greece and Spain, which no doubt remains a considerable concern.
In April 2008, the euro stood near .60 relative to the U.S. dollar. For the last four months, it has hovered around .30. Playing that ride lower is possible, though speculative, with ETFs like the ProShares UltraShort Euro (EUO), which moves double in the opposite direction of the euro.
The euro’s valuation remains prohibitively high and needs to fall to parity with the dollar – or even slightly below – before Western Europe can begin a sustainable recovery. Should this happen, a devalued euro would not only fuel European exports to a broader range of nations and to a number of customers, it would also create jobs and prop up some of the most economically fragile nations in the region.
For investors, that downward trend of the currency represents a significant headwind to euro-based equities. If the situation gets worse – as we expect – it would be wise to be patient before wading in. For now, we are prepared to sit on the sidelines for a bit longer. If the euro reaches par with the dollar, we would view that as an ideal time to increase our exposure to Europe.
When that time comes, we expect manufacturing firms in the region that export in-demand, high-end machinery and materials or have advantaged sales & distribution in emerging markets to be significant beneficiaries. Here are some examples:
*EAD France (EAD.FR) whose core business is commercial aircraft, “Airbus”, with its high current backlog of plane orders
*Rio Tinto (NYSE: RIO) with its production of iron ore for steel making, aluminum, copper and energy
*Unilever (NYSE: UN) the Anglo-Dutch food & household products maker with 60% of sales derived from emerging markets
Fundamentally speaking, a case can certainly be made that European stocks already trade at compelling prices. Based on 2013 earnings expectations, the Stoxx Europe 600 index trades at 11.5x earnings, which is cheaper than the 12.5x earnings average for the S&P 500. European companies also pay higher dividends than their American counterparts, averaging annual yields of 3.8% compared to 2.2% for the S&P 500. For U.S. investors, though, the currency headwinds cannot be ignored, as a continued slide by the euro toward par with the dollar could offset any positive gains in the short term.
Similar to the recent political discussion about austerity, a weakening currency will bring with it some pain. A devalued Euro would likely coincide with a lower standard of living for European citizens – something various financial leaders in the region have attempted to do via austerity measures aimed at lessening future debt obligations. Not surprisingly, those austerity measures – reduced government spending combined with higher proposed taxes – have been roundly rejected by the people. Market forces, however, may end up accomplishing what government leaders could not: repositioning Europe to become more competitive in the global economy.
2012 served as proof that a stabilizing European economy is vital to the health of global equity markets. Short-term currency pains should help lead to long-term gains, and as the Euro inches closer to par with the dollar, investors should be prepared to buy European stocks.
Ben Marks is president and chief investment officer of Marks Group Wealth Management (www.marksgroup.com), a Minnetonka, Minn.-based independent registered investment advisory with approximately 0 million in assets under management. Marks Group Wealth Management owns certain of the aforementioned stocks on behalf of their clients.