Watch European Earnings More Than the Catalonia Referendum

 | Oct 03, 2017 | 9:00 AM EDT
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Some foreign investors are reducing exposure to the eurozone after the Catalonia referendum at the weekend. But the mishandling by the Spanish government of the Catalonia independence referendum opens a way for investors outside Europe to get European assets on the cheap, something that could prove profitable over the long term.

As most everyone knows by now, last weekend many Catalonians chose to go out and vote in an independence referendum even though it had been declared illegal by Spain's Constitutional Court. Instead of allowing the vote to go ahead and simply ignore the results, the Spanish government sent the police to try to prevent people from voting.

Images of police brutality in Catalonia were beamed around the world; around 900 people were injured, and the crisis continues. On Tuesday, the main trade unions in the autonomous Spanish region, as well as most universities, are on strike in protest against the Madrid government.

This is only the beginning of what could turn into a protracted political crisis in Spain that would reverberate across the European Union. EU officials have called on both sides to start a dialogue, but other than putting pressure on Spanish Prime Minister Mariano Rajoy to negotiate, there is little the EU can do.

In response, the euro weakened against the dollar, losing around 2.4% since a high of 1.2026 hit on Aug. 29. Since the beginning of the year, the single European currency had appreciated by 14% against the U.S. dollar by then.

Events in Catalonia halted the euro's upward trajectory, which offers investors based in the U.S. an opportunity to get some exposure to Europe or increase that exposure if they already have some, as it is cheaper to buy euro-denominated assets now.

Skeptics could say that this is not the time to invest in Europe, but the eurozone's growth is on a solid footing and the weakening of the currency would be welcome news for exporters, adding to that growth.

The euro area's recovery has become entrenched. Domestic demand expanded by 0.5% in the second quarter, underpinning 0.6% growth in GDP quarter on quarter, according to Eurostat data. Rating agency Standard & Poor's forecasts this year's economic growth at 2.1%.

More importantly, the rating agency predicts above-trend performance for the four largest economies and sees the lowest dispersion in growth rates across all member states since the eurozone was created in 1999.

"This upturn is indeed benefiting the region as a whole," Jean-Michel Six, chief economist for Europe at S&P, said.

This is a crucial point for investors. While Spain could find itself in troubled political waters and uncertainty is rising in Germany because of the weakening of Angela Merkel's position and the entry in parliament of the Alternative for Germany right-wing party, the whole area's economy is expanding.

S&P economists expect investment to add more support to growth, with a 0.5 percentage-point contribution to GDP expansion this year and next year. Political tensions are part and parcel of the eurozone's fabric; it probably will muddle through, as it always does. As long as the economy is doing well, companies' earnings should grow. This is the important indicator investors should watch.

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