U.S. equity investors who have been unable to take their eyes off the careering
can be forgiven for overlooking another market debacle: the seemingly never ending fall of the euro. The pan-European currency, which merges the existing currencies of members of the
European Monetary Union
, has been on the skids ever since it was created 15 months ago.
Currency collapses are not new and have struck all major countries at one time or another. But in the case of the euro, the issues are different and the implications potentially important for anybody investing in American Depositary Receipts of European companies or putting money into global equity funds.
When the euro made its debut on Jan. 1, 1999, it fetched $1.15 and has traded as high as $1.17. As of today, it was worth around 92 cents. That 20%-plus drop makes European goods more competitive in the U.S., but when those profits are repatriated, the sellers' earnings take a hit.
The euro was consciously designed to bring about the merging of 11 of the 15 members of the European block (Germany, France, Italy, Spain, the Netherlands, Belgium, Austria, Portugal, Finland, Ireland and Luxembourg). The eurozone has a population of 291 million and total GNP of nearly $7 trillion. The overriding goal is to open up members' markets to each other and to encourage closer integration. In due course, there will actually be euro coins to replace individual national currencies.
describes it, "The single currency has been called both Europe's greatest achievement and biggest blunder. The changeover went without a hitch but the euro faced a difficult time on the financial markets."
Impact on U.S. Investors
Does it matter to the U.S. investor? The answer is yes, it does, and on four levels:
- Diversification. Anyone who wants international diversification in a stock (or bond) portfolio has little choice but go to euro-based companies. If the U.K. ultimately joins, this would leave only Japan as a major equity market outside the U.S. and the eurozone.
Impact on domestic U.S. companies. The fortunes of most
Dow or Nasdaq companies are significantly affected by international trade performance whether in goods, services or on the corporate balance sheet. A weak euro helps importers and harms exporters and companies with substantial capital investments in the zone. Of course, at its current valuation, it provides investment opportunities.
Market growth. The eurozone clearly has a different economic cycle than the U.S. and (if current forecasts are to be believed) is about to enjoy strong growth just as the U.S. may start to slow down.
Merger and acquisition opportunities. The euro opens the door to trans-European corporations. Currently, there is a clear movement to linking financial companies across Europe. U.S. institutions have a considerable advantage in access to capital and expertise in such link-ups.
For the international markets, the euro is still a strange beast. Its reputation as a stable measure of value has been damaged by its chronic decline and many commentators have already designated it a failure and an embarrassment. However, the picture is more complicated -- the battered euro has done some things right.
First the bad news: Any U.S. investor who put money into European investments 15 months ago probably took a hit on his portfolio. However, the European-based investors who plowed euros into dollar-based investments have done correspondingly well; currency gains have added nearly 20% to whatever the U.S. stock market delivered.
There isn't much disagreement about why the euro has dropped so much in its opening season. The European economy has underperformed compared with the U.S.
economy . Germany, the biggest economy in the eurozone, racked up GDP growth of just 1.2% last year vs. 4.2% in the U.S. On top of that, U.S. interest rates have been moving higher and attracting international funds into domestic markets. Even without the rate differential (short-term interest rates in the U.S. are now 2.5 percentage points higher than in Europe), there is a perception that eurozone nations still have many structural reforms to finish before their economies are capable of generating U.S.-style growth.
The good news is that the euro has clearly helped bring about a more open and less restrictive market across the Continent. Countries like Italy, which used to suffer from terminal inflation and currency weakness, have benefited from a more stable environment. This explains why there is a waiting list of countries planning to tie up with the EMU. The first new member is likely to be Greece, scheduled to join next year. Denmark is moving toward membership and several other nations are likely to apply soon.
For Americans, the euro is not a politically sensitive issue but it does represent a major change in the overseas business environment with significant threats and opportunities.
In the short term, the low level of the euro offers a good investment opportunity. The eurozone economy is improving and there is a real sense that the euro will recover in the second half of this year. Thus, good local currency returns should be supplemented by foreign exchange gains.
In the medium term, for the next year or so, there will be risk associated with diversifying into a euro-based portfolio. Nobody yet has seen a solid move higher in the currency and it's probably still too soon to call a bottom. Europe's financial leaders are confident that the worst is now over and better days are ahead.
The best way to play an uptick? While it's perfectly possible for individuals to take foreign exchange positions in the spot or futures markets, this is not advisable for most investors. The best way to play the uptick is selective buying of blue-chip equities in Germany or France that will benefit from the predicted turnaround in the euro.
"The eurozone offers opportunities at these levels," says Tim Fox at
Standard Chartered Bank
. "It's tempting to add European assets to your portfolio for the longer term. There are some big movers in France and Germany and you should be able to buy in at good average prices." While Fox sees political and economic issues standing in the way of closer integration, he is definitely bullish on the opportunity for profitable investment in an expanding eurozone.
Over time, the euro will continue to be a force for change that will make Europe more competitive. Only last weekend, for example, it was announced that the
London Stock Exchange
is planning a major merger with its counterpart in Germany. Financial markets are already well integrated and this can only continue in other parts of the economy. As the euro expands in scope, there is no doubt that many more countries in Scandinavia and Central and Southern Europe will be brought fully into the single currency. Early evidence is that the benefits of eurozone membership are particularly significant for smaller countries. Ireland, for example, is generally regarded as having received a real boost from its position in the eurozone.
So don't be put off by the euro's early travails. They offer a great opportunity to get on board just when the omens look encouraging.