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21 Aug 2017

Where the euro goes, equities shouldn’t

 

The relationship between the euro and eurozone equities isn’t stable over time. It should, in theory, be inverted. Earlier this year however, both asset classes rode the wave as the economic outlook strengthened, elections passed without upset and money flowed to broad market indices like the Euro Stoxx 50.

Since May, the ties have weakened as the chart below shows.  The euro has continued its climb, but equities have eased. Some, but not all, exporters are suffering. That may just be because the market is yet to fully price in the FX impact for these companies, but it’s probably just a matter of time. Healthcare, staples and capital goods have been hardest hit by the headwinds. Oil-linked plays have also been under the pump.  

Domestic names are strengthening as a stronger euro creates more purchasing power for the eurozone’s ever more confident consumers. The need for selectivity is more apparent than ever.

change in correlation graph

Think small, be local

We still favour mid-caps because they generate more of their revenue from domestic markets than their more global, larger-cap peers do. But the view does need some refinement in the current climate. For now:

  • Domestic-focused sectors like financials, telecoms and utilities have fared better during the recent weakness

  • But rising bond yields - the elephant in the room - present a threat. Higher yields are the perfect environment for financials, but telecoms and utilities tend to fare more poorly. No wonder eurozone financials ETFs enjoyed a record month for inflows in July

  • Away from financials, opportunities become that little bit harder to find. Size really could matter to performance
  • Small-caps, with their higher share of domestic revenue and more attractive sector mix (high weight  to financials, low weight to defensive and growth sectors), look attractive to us

  • Futhermore, small-caps have historically performed well on an abololute and relative basis in a rising rate environment

Small-cap sector mix

Sector Weight %
Industrials 28.37
Financials 22.53
Consummer Goods 11.72
Consummer Services 8.54
Technology 7.69
Health Care 6.83
Basics Materials 4.92
Utilities 4.25
Telecommunications 2.57
Oil & Gas 1.78



Source MSCI, 16 August 2017

Chase cheap​

Small-cap valuations still look cheap to us relative to large-caps. Ultimately, the combination of that domestic focus, a more appealing mix of sectors and reasonable valuations is what makes small caps attractive to us right now. History also suggests value as a style is more likely to outperform growth when the euro appreciates. 
 

How small-cap valuations compare

EMU small-caps vs. large-caps, relative P/E

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Disclaimers​

Data and opinions as at 16 August 2017 unless otherwise stated. SG research taken from the Equity Strategy’s Europe Equity Compass, published on 10 August 2017.

This communication is for professional clients and qualified investors only.

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets In Financial Instruments Directive 2004/39/EC.

This document is of a commercial nature and not of a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor International Asset Management or any of their respective affiliates or subsidiaries to purchase or sell the product referred to herein.

We recommend to investors who wish to obtain further information on their tax status that they seek assistance from their tax advisor. The attention of the investor is drawn to the fact that the net asset value stated in this document (as the case may be) cannot be used as a basis for subscriptions and/or redemptions. The market information displayed in this document is based on data at a given moment and may change from time to time. The figures relating to past performances refer or relate to past periods and are not a reliable indicator of future results. This also applies to historical market data. The potential return may be reduced by the effect of commissions, fees, taxes or other charges borne by the investor.

Lyxor International Asset Management (Lyxor ETF), société par actions simplifiée having its registered office at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorized and regulated by the Autorité des Marchés Financiers (AMF) under the UCITS Directive and the AIFM Directive (2011/31/EU). Lyxor ETF is represented in the UK by Lyxor Asset Management UK LLP, which is authorised and regulated by the Financial Conduct Authority in the UK under Registration Number 435658.

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