BofA: The impact of a weak euro on equities and the outlook going forward

Her Eleftherias Kourtalis

The weakness of the euro this year has dampened the sell-off in European stocks and led to their outperformance against global stocks, Bank of America notes in a report today. The less scope for the euro to fall, after the recent weakening, leaves EU stocks more exposed to further weakening of growth, as it emphasizes and that is why it remains neutral on European stocks.

The devaluation has dampened the sell-off in European stocks, BofA explained, as the 6% drop in the trade-weighted euro index seen this year provided a significant cushion for European stocks, but was not enough to offset the “hit”. from slowing growth and rising bond yields, which together sent the Stoxx 600 down 19% from January highs to June lows. Without the support from the devaluation of the euro, the market would probably have plunged almost 25%, as the US bank estimates.

Euro weakness has also been a key support for European equities’ performance against global equities this year, with the 10%+ fall in the EUR/USD rate accounting for most of the 5% outperformance for European equities seen by January.

However, most of the boost from a weaker euro has probably already taken place. BofA does not expect further declines for the euro in its baseline scenario, while its year-end EUR/USD target is set at 1.05. This means that European equities are likely to be relatively more exposed to any further weakening of growth momentum as the protective effect of exchange rate weakness wears off.

In its baseline scenario, it sees a modest further decline for the euro area PMI to 49 points and the global PMI (from 51.5 to 50) in the coming months. Much of this growth weakness has already been priced into stock market indices, so BofA’s baseline scenario sees modest further declines for the Stoxx 600, although a recession scenario in which euro area PMI and global PMIs remain likely they would fall to 43 and 47, respectively, which would imply a further 10%+ plunge in the stock. Relative to global equities, BofA’s key macroeconomic assumptions are consistent with around 5% underperformance for European equities, rising to 7% in a recession scenario.

Based on the above, BofA chooses to remain neutral on European equities, overweight the consumer staples and utilities sectors and underweight the banks and auto industry. “We believe growth momentum will continue to weaken in the coming months, with the macroeconomic cycle – and therefore asset prices – bottoming out by the first quarter of next year,” he notes.

As it explains, it remains neutral on European shares, having lifted its stance from negative in June, as it prefers to focus on other assets that are less exposed to recession risks, although it remains underweight on Europeans compared to global stocks.

Among cyclical assets, it is underweight banks, autos and value-to-growth stocks, which have underperformance margins of 20%+, 18% and 9% in a recession scenario, respectively.

Among defensive assets, he is overweight food and beverages, personal and household goods and utilities, which he expects to outperform by about 15% in a recession scenario.