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European Stocks are Weighed Down by Currency Exposure

David Becker
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www.iforex.com
European Stocks are Weighed Down by Currency Exposure

European stocks weakened as the French CAC Index ($CAC), German DAX Index ($DAX) and the FTSE Index ($FTSE) moved sharply lower on Monday and Tuesday. On Wednesday the European markets rebounded despite a softer than expected IFO survey. The weakness at the beginning of the week was attributed to disappointment with the Eurozone PMIs.

As with US small-caps, European stocks are underperforming the S&P 500 in general because these three indices did not clear their summer highs, whereas the S&P 500 hit a new high this month.

The German DAX Index ($DAX) surged back to the 9800-9900 area, but fell short of its summer highs and moved lower the last two days.

The ETFs, which follow these markets, have also been under pressure. ETFs that are priced in dollars and hold foreign equities are affected by exchange rates. This means you should consider the “currency” component when investing or trading ETFs that are based on foreign stocks. ETFs traded in the US are priced in dollars, but their holdings are often priced in the local currency. This means changes in the exchange rate will often affect performance. With the German DAX Index Germany iShares (EWG), the Euro ETF (FXE) has a negative effect on the ETF. Notice how the $DAX surged around 9% and reached its June low, but the Germany iShares only advanced 5.4% and fell well short of hits June low.

EWG seriously underperformed the DAX over the last few weeks because the Euro fell sharply. The Euro ETF declined over 4% from early August to mid-September. Weakness in the Euro affected the performance of EWG because the individual stock holdings are priced in Euros and EWG is price in Dollars. Even though the stock prices move higher in Euro terms, the decline in the EURUSD exchange rate weighed on the ETF.

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