Europeans, who are fond of traveling, will discover over the Easter holiday period, at the latest, the downside to a weak currency. They will now get considerably less for their euros in many countries, meaning the disparities will become visible and tangible to all now. Regional divergences are evident elsewhere too. While Americans can be happy about the recent wave of weakness in oil prices at the gas station, little or none of this is reaching residents of the Eurozone. And when procuring supplies or conducting cross-border takeovers, U.S.-dollar-based companies have been enjoying relative advantages over euro-based firms lately.
Why am I mentioning this? Surely the weak euro is one of the reasons we like Eurozone stocks? Let us thus have a look at the other three reasons: cheap oil, low interest rates and the – hopefully not just for this reason – resulting profit growth. But however strong the tailwind from oil, euro and interest rates might be for Europe at the moment, it is finite. Or at least it is declining in terms of momentum, after oil prices have already dropped by 50 percentage points, the euro has lost up to a quarter against the U.S. dollar in less than a year and key parts of the yield curve have slipped into negative territory. Based on classic valuation criteria and following the latest market rally in the Eurozone, that is likely to limit further upward potential and drive up volatility.
We should be aware of this risk for the current year, and likewise of the danger that Europe’s markets could overshoot our price targets. After all, like it or not, together with the European Central Bank (ECB), all other market participants are part of the big global experiment in QE, something that raises several questions: Are historical price-earnings (P/E) ratios still a good yardstick? How is the low-interest environment and the cash injection from the ECB and the Bank of Japan (BOJ) still affecting stock valuations? And how is it affecting the investment behavior of pension funds, life insurers or foundations, all of which traditionally overweight bonds in their portfolios? We believe that we are just seeing the start of huge capital shifts, particularly in Europe, that will herald the temporary end of interest and compound interest. In our opinion, the beneficiaries will remain, at least for the present, high-risk asset classes, particularly stocks. However, because of the fluctuations that can be expected in the course of the year, a good mixture, meaning a multi-asset orientation, is likely to become increasingly important.