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Euro Currency Appreciation

02/07/2013

This morning, European Central Bank President Mario Draghi acknowledged exactly what I have recently grown concerned over, sharp euro currency appreciation. On CNBC Halftime, my recent comments to reduce long equity beta exposure was largely motivated by these concerns. I am not alone in this view. Multiple investment banks have also recently warned about it. In fact, on February 1, Goldman Sachs advised clients to close out long euro currency/U.S dollar positions.

Year to date, the euro currency has made an aggressive advance to a 13-month high of 1.3711 on February 1. However, it is not predicated on a European economic “growth” rally. Yes, the economic contraction has stabilized in Europe, but parts of the eurozone still remain in recession. Rather, the euro currency has experienced “collateral damage” from the recent overly dovish monetary policy positions emanating from the Bank of Japan, Bank of England, and even here in the United States. Once again, in a world of competitive currency devaluation, Europe has fallen behind.

2012 should be defined as a period of healing for Europe. A larger contributor to that healing was the value of the euro currency (Figure 1.1), which traded between 1.20 and 1.35, with a yearly average of 1.2860. It was that non-volatile yet marginally weak currency that allowed the European periphery to gain competitive traction on its core peers and for mild inflation to be imported into Germany. Both were necessary to Europe’s overall economic healing witnessed in the second half of 2012. It also contributed to strong 2012 outperformance for the German DAX (Figure 1.2) at +31.42%. Year to date, the DAX (Figures 1.3 & 1.4) is underperforming its developed nation peers with an equity index performance of -0.154%.

What I expect to follow is an attempt by European Central Bank members to use further language to halt a larger advance above 1.40. Mr. Draghi attempted some verbal intervention today. Should that message fail to keep the euro below 1.40, investors should expect an ECB rate cut from the current 0.75% benchmark rate.

What this means for the investor portfolio is potentially favorable on balance for 2013. Yes, in the near term, some euro weakness will lift the U.S. dollar and temper the enthusiasm surrounding the SPX. However, investors should not view this development as a “show stopper” for the SPX, only a small intermission.

The ability to arrest the euro advance is imperative for keeping the eurozone recovery on track. If the ECB is successful, a potential investment theme would be to return allocations to the German DAX back to overweight as suggested in last July’s Q3 2012 playbook “The Trend is Your Friend.”

Figure 1.1 Euro Currency 2012

Source:  Bloomberg

Figure 1.3 German DAX 2013

Source:  Bloomberg

Figure 1.3 German DAX 2013

Source:  Bloomberg

Figure 1.4 German DAX January 1, 2012 to February 7, 2013

Source:  Bloomberg

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.