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For the best returns on European equities, go local, expert says

Natasha Turak

A strengthening euro is making life more difficult for the euro zone's exporters — so if you're making a choice on stocks, go domestic, one equities expert told CNBC Wednesday.

Describing the double-edged sword that is economic growth accompanied by a simultaneously rising currency, Nick Nelson, head of European equity strategy at UBS, said, "That is definitely the trade-off, and that's why we would focus on the domestics in Europe rather than the exporters."

The euro zone is seeing long-awaited growth after nearly a decade of lagging since the financial crisis and the recession following the continent's sovereign debt crisis. But as growth rebounds, so does the 19-member currency, making earnings tighter for outward-facing companies that rely heavily on exports.

"We are having very strong economic growth in Europe, that is where about just under half of the revenues for European companies come from, but you've got large exposure overseas," Nelson said, explaining that roughly 20 percent of European company sales go to the U.S. and 30 percent to rest of world, predominantly Asia.

"Clearly those are areas that are going to get hit by the stronger euro, so our preference has been quite clear through the second half of last year when we saw the euro strengthening, to go to domestic plays because that is where a lot of the economic growth is. It's also where you avoid any of the currency headwind."

The euro stood at 1.2336 against the dollar on Wednesday morning, an appreciation of more than 16 percent since this time last year, and it's also risen 3.8 percent against the pound sterling in the same time.

Euro zone businesses saw orders and activity increasing at their fastest pace in more than a decade as 2018 began, a welcome sign for the European Central Bank as it begins a move away from quantitative easing.

However, European stocks traded lower Wednesday morning on the news of weaker Purchasing Managers' Index (PMI) survey figures. The manufacturing sector's economic health metric for the euro zone slipped to 57.5 this month compared to 58.8 in January, which was its highest since 2006. A figure above 50 still represents an expansion in the sector.

Analysts say this hints at a slower pace of growth ahead, though business activity is still around record highs and most expect levels to remain healthy.

"Despite the fall in the euro zone PMI business surveys they remain at a level which would historically have been consistent with still strong growth in the euro zone," said Mike Bell, global market strategist at J.P. Morgan Asset Management, in an email note. "The PMI is still consistent with strong earnings growth for European companies in 2018 and is not a reason to expect trouble ahead for euro zone equities."

Nelson largely agreed, noting that despite a slightly more challenging outlook, general sentiment remains calm. "We think this year the stronger euro takes maybe three percentage points off of European earnings. So it's a headwind, but not a disaster."