A stronger currency tends to be negative for regions that are home to companies that export to a global customer base. Domestic currency strength can push up production costs, increasing the competitiveness of firms from other parts of the world. Here, Richard Pease and Simon Rowe, managers of the Henderson European Growth Fund, discuss the broader implications for Europe and how many companies in the region are still managing to perform well:
How has euro appreciation affected Europe’s economy?
Richard: Europe is out of crisis and showing early signs of what everyone hopes will be a sustained recovery. However, a near-10 per cent rise in the euro versus the US dollar since August 2012 has contributed to a deterioration of price and cost competitiveness for European exporters. At the same time, high unemployment levels (12.1 per cent in October 2013) have pushed down labour costs. Firms have been able to discount prices in an effort to offset squeezed profit margins, but this in turn has put downward pressure on the rate of inflation. The risk comes if this weakening inflation turns into deflation (where prices persistently fall). Deflation can be hard to escape for weak economies (in Europe, typically in the south), increasing the real cost of servicing already prohibitively high debt levels.
Simon: A strong euro represents an obvious headwind for companies with a euro-heavy cost base. However, the best companies have long-since recognised the need to reduce their dependence on the Eurozone and have factories around the world, such as in China, Mexico or Brazil. It is also worth remembering that in some highly automated industries, the proportion of labour costs is relatively small, meaning that a move in the euro is less significant than it seems.
How have companies adapted to a currency that has generally held up, when economies have not?
Simon: Globalisation has changed many things, contributing to a downward trend in labour costs and creating extended supply chains. The strongest companies are also shifting research, where possible, from expensive, developed countries, to emerging markets where wages are much lower and productivity higher. These moves are probably more important than collaboration and cooperation.
A further factor to consider is the pricing power of a company. If you look at Swiss or Swedish firms, many of these have adapted to the adverse impact of currency appreciation, surviving through investments in productivity and because customers are prepared to pay a premium for their products. In this case, pricing power can offset currency impacts; and investors simply have to avoid commoditised products and sectors.
Richard: Product differentiation, primarily through quality, allows companies to compete against their lower-cost rivals. Take Infineon, for example, a European manufacturer of high-powered semi-conductors for a worldwide variety of transport networks. Infineon offers an optimal product to its clients, which helps to sustain revenues despite short-term currency headwinds. Clients may say to the firm that they can source their products at a lower price from rival manufacturers in Japan, for example. But Infineon continues to benefit from growing underlying demand for its high quality, reliable and durable products.
How has the European Central Bank reacted?
Richard: It is no surprise that the European Central Bank (ECB) seems to be paying greater attention to the impact of the currency. The interest rate cut at the beginning of November could be seen as an attempt to reverse the currency gains we have seen in 2013, thereby increasing the competitiveness of countries like Greece and Portugal. Thus far, however, the euro has stayed rock solid.
Simon: The ECB is no doubt hoping that the US Federal Reserve’s delayed decision to taper its monthly $85 billion bond-buying stimulus measures will weaken the euro against the dollar. Tapering will happen in stages, and there should be consistent exchange rate depreciation once it takes hold. Each time the Fed decides to reduce its monthly bond purchases, the dollar should strengthen a little bit more against other major currencies. This may take some of the pressure off the European economy and rejuvenate the competiveness of companies based in the region.
Has euro strength made a difference to how you invest?
Richard: We try to separate discussions about Europe from those about companies based in the region. Europe is home to many world-class businesses with global reach, reliable recurring revenues and little debt, quite often run by management/family teams with a big stake in the business. These are qualities you would want in any business, irrespective of the macroeconomic backdrop.
