In a widely anticipated announcement this morning, European Central Bank announced that it would be expanding its asset purchases to include government bonds. The ECB is set to join the Bank of Japan, Federal Reserve, and the Bank of England in the list of central banks which have bought longer-term sovereign debt, and also plans to increase its purchases of asset-backed securities and covered bonds.
The central bank will buy €60-billion worth of these assets per month from March of this year until September 2016, an amount that exceeded the whispers that preceded the decision. Growth and inflation in the euro area remain abysmally low, prompting the central bank to pursue this aggressive form of monetary stimulus.
The market's initial reaction to this news was decisive: – the Euro Stoxx 50 index rose, gold broke above 1,300 (U.S.) per ounce, European government bond yields fell and the euro hit the skids, tumbling to its lowest level against the U.S. dollar in more than a decade.
Mario Draghi, president of the ECB, cautioned that this move was no panacea for what ails the European Union.
"For growth to pick up, you need investment; for investment, you need confidence, and for confidence, you need structural reforms," he said.
At this juncture, Canadian investors should take time to consider whether their portfolios include any stocks that have exposure to Europe, as the central bank's move offers both reason to be optimistic on these names over the medium-term, but in some cases, cause to be pessimistic in the near-term.
Many natural resources companies – Bankers Petroleum Ltd., Lundin Mining Corporation, Dundee Precious Metals Inc., and Ithaca Energy Inc., to name a few – generate the vast majority of their revenues on the continent. However, the performance of these firms is also highly dependent upon the price of the underlying commodities they sell, which have, in most cases, deteriorated in value as of late.
There are two household names that earned more than 40 per cent of their revenues in Europe in the last fiscal year: Magna International Inc. and Bombardier Inc.
Magna has managed to grow revenues in Europe in every year since 2009 - no small feat given the widespread stagnation on the continent – but it isn't poised to have much success there in 2015. For every cent the U.S. dollar gains on the euro, the auto parts manufacturer will take a top-line hit of $110-million, according to Credit Suisse analyst Daniel Galves.
A weakening euro relative to the loonie will adversely affect all the companies that report in Canadian dollars and generate revenues on the continent, except, of course, the natural resource producers. But that isn't the only revenue headwind that Magna faces in the region. The company is allowing some of its parts programs to mature, as they fail to provide an adequate return, and the production of two lines of vehicles for which it manufactures parts is tailing off. By 2017, however, management indicated that production sales in Europe will increase by $1.75-billion relative to guidance provided for 2015.
Bombardier has fallen on tough times recently, with analysts questioning the credibility of management and the viability of the company. The firm's Transportation division boasts over 100 projects in Europe, which exceeds its cumulative ventures in the Americas, Asia-Pacific, the Middle East, and Africa, but its sales in the region have shrank from 2011 to 2013.
Despite the near-term foreign exchange headwind, both of these companies should benefit over the medium-term from a cyclical pick-up in demand in the event that the European economy gains traction.
There are also two REITs, Dream Global Real Estate Investment Trust and Granite Real Estate Investment Trust, which generate 100 and 43 per cent of their revenues from Europe, respectively. Dream Global's properties are located in Germany, and the company counts AIG, BNP Paribas, and Google among its key tenants. Granite's primary tenant is Magna. Inasmuch as the ECB's bond purchases help depress yields on fixed income around the globe, they serve as a boon to this segment, in general.