Yahoo Finance Care about global shares? Then pray for Europe…
‘Progress comes to those who train and train; reliance on secret techniques will get you nowhere’ - Morihei Ueshiba
It really is ALL about Europe if you care about global equity markets. I guess you are imagining that this is going to be yet another article about a ‘hard’ or ‘soft’ Brexit and related. Of course this issue – especially if you are sitting in the UK – is far from irrelevant but actually Europe is important for other reasons.
I wrote last week about the Pound and why investors should not panic because (1) the currency weakness is not all bad news and more importantly; (2) Sterling will recover a bit over the next year. However in the shorter-term the Pound being weak has helped inflame the US dollar.
Now what is wrong with a bit of US dollar strength I hear you ask? After all the Federal Reserve keep on flirting with an interest rate rise and from a political risk perspective the more predictable Hillary Clinton has stretched out a poll lead. It seems quite reasonable that the Greenback should be stretching its legs.
Of course you would be correct with such analysis but the Pound dumping, the realisation by the Japanese authorities that maybe a strong yen is not the way to go to boost the moribund local economy and the upfront commentary by the Swiss central bank earlier this week calling for a lower franc has meant that the US dollar has got a bit fruity.
Now this causes problems for two important constituent groups. The first are the emerging markets. Many have considerable US dollar denominated debts and if the US currency goes up then these start to impose a bit more pain. The second reason is that many commodities are quoted in US dollars and when that currency goes up so does their prices. Higher commodity prices crimp economic activity. Put the two impacts together and it is not good news typically for the world economy or equity markets. Just look at how the Chinese currency – which nominally tracks the US dollar – is at a six year low against the US currency as they feel the competitive pressure of trying to maintain the linkage. A big, formal Chinese devaluation would certainly negatively capture the attention of the world’s investors.
The last time we had a bout of US dollar strength was in the first couple of months of this year. You may remember that instead of the “FTSE 7000” levels of the last couple of weeks, the FTSE-100 index was kicking around below 5600 index points. Almost all other global markets were similarly poor. A fall back to such levels would certainly hurt the value of your pension fund or ISA holdings.
Step forward then our battered and under pressure hero who is the only one who can save the day (excepting a miraculous uplift in the polls by Mr Trump): the much maligned euro. If you take a look at global currency markets then the only two Premier League currencies are the US dollar and the euro. As exchange rates are always a two-way street we basically need the dollar to go down and the euro up.
And this is why you should pray for Europe. Clearly matters are somewhat troubled currently with Brexit, political angst, Italian constitutional vote concerns, the migrant crisis, low economic growth…and much more. It is easy to be pessimistic and the world’s investors are: big outflows from Europe (including the UK) equity markets over recent months and a general lack of faith in the euro which sits at barely 1.10 against the US currency when the OECD tells us that fair value is in the 1.30s.
What I am trying to say is that there are big issues but also a big discount against a reasonable value level for the euro. All it is going to take to approach the equity market friendly world of a rising euro and a falling US dollar is some bit of extra faith that Europe is edging towards a better and more sustainable economic and political backdrop.
Some will believe that the structure is intrinsically flawed and the Brexit vote was the beginning of the end for the European Union and the ideals of deep European integration. If this is so then get your tin hats on because global equity markets are going to be volatile. However if you believe that it is only when their backs are to the wall that the European leaders actually start to consider sensible and pragmatic moves then there is some hope. Mix this in with the benefits of all that late-to-the-party stimulus that the European Central Bank has employed in the last year or two and just maybe you could have a better 2017 story around Europe than you think even if Brexit per se remains mired in uncertainty.
And if this is the broad scenario, the euro will catch a bit more attention and go up…and so will equity markets generally in 2017.
In conclusion: keep watching the euro as the wealth of your portfolio is highly likely to be influenced by its movements!
Chris Bailey has 20 years of investment industry experience at long-only and long-short institutions as a global multi-asset fund manager, strategist/macro thinker and, in the earlier part of his career, as a securities and fund analyst.
In 2013 he founded Financial Orbit focusing on daily macroeconomic comment and securities analysis.
The content on this page does not constitute financial advice and is provided for general information purposes only. Nothing on this page should be regarded as an offer to conduct investment business or to buy/sell any investment
