What Is Next For European Stock Markets?

May 9th, 2015
in contributors

by Michael Grogan, First Class Analytics

While a weak euro had initially provided a boon to European stock markets, a strong U.S. Dollar appears to have out worn its welcome, with the Euro having appreciated from a level of 1.058 in mid-April to a level of 1.1146 at the time of writing. Additionally, the German DAX stock market index has depreciated by over 8% over the same period to a level of 11350.15. Similarly, the French CAC40 index is down by 5%, and the IBEX 35 in Spain has also dropped by 5%.

Follow up:

Indeed, a big driver behind higher stock returns across Europe was a weak currency. With concerns of overvaluation across U.S. equity markets, low interest rates across Europe not only facilitated access to cheap credit for equity investment, but a weaker euro also allowed international investors the opportunity to buy European stocks at cheaper rates than would be possible otherwise. All else being equal, if the Euro strengthens then we can expect stock markets to retract and this is what has been happening over the past month.

However, on Wednesday markets broadly rose higher despite a stronger euro, with the CAC 40, DAX and IBEX 35 up by 0.15%, 0.20% and 0.43% respectively. This was largely in response to positive economic reports emerging from the Eurozone coupled with positive earnings data across various sectors.

I have been arguing that quantitative easing will only work so much when it comes to promoting real growth. While a low currency had lured investors due to overall lower cost of investment, eventually stock markets will also decline if they are not supplemented by growth in the real economy. However, with the European Commission predicting 1.5% growth this year and 1.9% for 2016, stock markets could be poised to appreciate further even with a rising euro. In particular, peripheral countries that saw lower than average growth rates may even be poised to outperform larger European countries. For instance, while Germany is forecast to see growth of 1.9% this year, growth in Spain is set to reach 2.8%.

Moreover, Spanish banking stocks rose significantly at the end of April, with Banco Popular (MADRID:POP) rising by 6.80% and B. Sabadell (MADRID:SABE) rising by over 3%. Granted, Spain still has issues with its overall banking sector given high unemployment and significant bank aid still yet to be recovered. However, the data seems to suggest that an economic recovery in Spain will likely yield positive benefits for the country's stock markets, which up till now have been avoided by investors relative to "safer" markets such as Germany. In this context, I see stock markets in peripheral countries such as Spain as having significantly more upside than that of France and Germany if economic growth continues to improve.

In conclusion, while a weaker euro has been the initial catalyst for rising stock markets in Europe, this now appears to be driven by stronger economic growth across the Eurozone and I expect this to continue in spite of a rising euro. Moreover, given a higher than average growth rate in Spain - I will be very interested in seeing how the IBEX 35 performs from here.

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