What's Driving The Euro Higher And 4 Stocks That Will Benefit

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Includes: BAX, BKNG, EWG, FXE, HEWG, KO, MCD, SPY
by: Chris B Murphy
Summary

The euro is up over 8% since December 2016 on broad-based market rallies throughout Europe.

Despite the European Central Bank's dovish tone on Thursday, the euro should continue to rise, taking U.S. companies with assets in Europe along for the ride.

In this article, we analyze the surging European markets, driving the euro, but also driving McDonald's Corporation, Coca-Cola Company, Baxter International, and The Priceline Group Inc.

With the euro rising this year, the stock prices of U.S. companies with assets in Europe have been rising as well. These U.S. companies stand to benefit from European growth and a stronger euro since their assets and sales are translated back to dollars at quarter's end, and increase in value, provided they didn't hedge at an unfavorable rate.

In this analysis, we'll look at what's driving the euro higher and four U.S. companies that will likely benefit.

Four companies that benefit from a stronger euro include McDonald's Corporation (NYSE:MCD), Baxter International Inc (NYSE:BAX), The Coca-Cola Company (NYSE:KO), and The Priceline Group Inc (PCLN) to name a few. Also, those invested in the euro through the CurrencyShares Euro Trust ETF (NYSEARCA:FXE) would also benefit from a stronger euro.

With most of the European elections behind us, investors may be asking what comes after the elections and Brexit negotiations?

As investors look to get in and capitalize on the recent gains in the European markets, they must look to the Euro Zone's central bank for cues to the outlook for growth and inflation.

The role of The European Central Bank - ECB:

During the European Central Bank or ECB meeting on Thursday, the central bank President Mario Draghi revised their growth forecasts higher, and their inflation forecasts lower for this year.

Here are the highlights of the ECB meeting:

  • Draghi stated that inflation remained low and below their 2% target. The ECB's forecast for inflation for this year was revised lower to 1.5% from 1.7% previously.

"Underlying inflation remains low and have yet to show convincing signs of a pick up." - ECB Press Conference.

  • However, the ECB's forecast for eurozone growth was upgraded from 1.9% from 1.8%. Draghi changed the wording from their prior meeting stating that growth was "broadly balanced" rather than the typical warning of risks to the downside.

Takeaways and impact on the euro:

  • It appeared to me that the ECB would have been more hawkish but lower than expected inflation numbers, "mainly reflecting oil prices," gave little reason for the ECB to dial back the current easy monetary policy.
  • Euro weakness is possible if inflation comes in even lower than the 1.5% forecast at some point this year. Any downward pressure on the euro would be a negative for U.S. companies with European exposure.

However, given that economic growth is likely to be solid and political risks have subsided, traders and investors looking to get in and go long will be jumping at any opportunities to buy on the dips. Those that benefit from a possible pick up in long positions, will be the euro, equities or bonds with exposure to Europe.

Here's how investors have pushed European markets and the euro higher so far YTD.

The German DAX (similar to the U.S. DOW) as traded through ETFs have posted double-digit gains.

In the chart, we see the iShares MSCI Germany ETF (NYSEARCA:EWG) is up almost 18%, and the iShares Currency Hedged MSCI Germany ETF (NYSEARCA:HEWG) is up over 11% YTD.

EWG Chart

EWG data by YCharts

U.S. markets are not the only markets riding the bullish wave. Here's a chart showing just how the broad the rally is throughout Europe.

Typically, if the bond market is rallying, sending yields lower, equities tend to fall as well as investors get nervous over economic conditions or geopolitical events. Also, bank stocks tend to fall as yields come off putting added downward pressure on equity markets and ETFs.

Instead, we're seeing a broad-based rally throughout Europe as reflected in the 8% gain YTD in the euro versus the U.S. dollar.

U.S. corporations with sales and business operations in Europe stand to gain from the overall bullish trend developing in the Euro zone.

The below chart contains four companies with significant exposure to Europe that are performing well YTD. These companies will continue to benefit from any broad-based investor optimism in Europe.

KO Chart

In most cases, our international companies are outperforming the S&P 500 and the Dow so far this year. As seen from the previous chart, the German DAX has also outperformed (+25%) the S&P and Dow YTD.

In fairness, the Dow and S&P are up 28% and 17% respectively, since the U.S. Presidential election in November. However, the gains in Europe are nonetheless impressive.

Here's a look at the S&P 500 performance YTD through the SPDR S&P 500 Trust ETF (NYSEARCA:SPY).

SPY Chart

SPY data by YCharts

In my article, McDonald's: How The Euro Can Impact The Stock Price, we analyzed the historical correlation between the euro and the stock price. Of course, there are many factors that drive the stock.

However, it's clear that if we see a bullish run in the euro for the remainder of 2017, as a result of broad-based investor optimism, investors long McDonald's and the other international companies cited earlier in this article should benefit. Again, the euro won't be the impetus for all of their price appreciation, but it should in part, be a driving force behind these stocks helping to give them a lift higher.

How closely do the international companies on our list to correlate to the euro?

Coca-Cola Company Chart:

KO Chart

KO data by YCharts

Priceline Group Chart:

Euro to US Dollar Exchange Rate Chart

Euro to US Dollar Exchange Rate data by YCharts

Although not as positively correlated to the euro as other companies in our sample, Priceline has been bullish for most of the past year. However, when the euro fell, the price of PCLN stalled but has since resumed its correlation with the euro.

McDonald's Corporation:

Here's a chart from my prior article where I matched the historical stock price moves with the euro over the past few years. Of course, it's a not a one-to-one correlation, but any large move in the euro can be sure to impact McDonald's stock price.

Here's over the past year:

MCD Chart

MCD data by YCharts

And lastly, Baxter International:

BAX Chart

BAX data by YCharts

Key Takeaways:

  • There are times when the correlation broke down as in the case of the U.S. election of Mr. Trump where we saw the euro weaken versus the dollar while equities rallied.
  • However, if you notice from the above charts, the election is one of the times, and in some cases the only time, the correlation between the euro and the international companies in our sample broke down.
  • In other words, it will take a fairly significant market-moving, volatile event to break the correlation and it's unlikely that correlation would sever over the long-term.
  • If we continue to see broad-based support in European markets, the euro should benefit. It's likely that once Brexit has been put in the rear-view mirror, and with the political turmoil in Europe having abated, investor optimism should continue to improve.
  • Despite the ECB continuing their quantitative easing due to lower than expected inflation, it's clear Mario Draghi believes that growth should continue to pick up in Europe. And if we see evidence of that growth, look for ECB verbal intervention hinting at further unwinding of the ECB's balance sheet. As a result, the market would view a taper as hawkish and would likely translate to a higher euro.
  • It's likely we'll see the euro rise to 1.15 in the coming weeks and months, although not without pullbacks. And since the euro and the international companies in our sample are tied at the hip, it's likely they'll get a lift from any rise in the euro in the coming months. Although the hard numbers might not show up until the next quarter or so, we should see results beforehand, reflected in their stock prices. Again, the euro by itself is not the key driver for these stocks.

In summary, if broad-based investor optimism continues to build in Europe, investment flows into the Euro zone should increase, leading to a firmer euro, and the flows would likely translate to further long positions in the international companies outlined in this article.

Good luck.

More articles to follow to keep you updated on the risks that exist for equities, financials, and currencies including central bank and Treasury analysis.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In full disclosure, this analysis is not a recommendation to buy or sell at a specific level. I'm not a financial advisor. My goal is to help you identify areas of risk in your portfolio, identify areas of resistance and support, and areas where volatility is likely to rise. By no means is this article an all-inclusive analysis of this stock. Past performance does not guarantee future results.