Graphic: Stock investors scout out Europe's rate-cut winners

Securitas AB

07/06/2024 06:00

By Danilo Masoni, Samuel Indyk and Lucy Raitano
       MILAN/LONDON, June 7 (Reuters) - Investors in European
equities are stepping up their search for stocks that are likely
to benefit from lower borrowing costs, after the European
Central Bank's (ECB) first interest-rate cut in almost five
years.
    While the cut was expected, analysts see the move as a
potential turning point for beaten-down sectors like utilities
and small caps, and even highly shorted stocks, which have
suffered as rates have risen and stayed high. Banks, which have
been some of the biggest beneficiaries of policy tightening,
could instead be in for profit-taking.
    Much depends on how fast inflation falls toward the central
bank's 2% target, allowing for more cuts in the coming months as
the region's economy recovers.
    "Typically, policy easing is supportive for European
equities," said Citi strategist Beata Manthey. "Combined with an
inflecting earnings picture, this should help justify some
additional upside".
    After Thursday's quarter-point cut from a record 4%, the
ECB's deposit rate now stands at 3.75%. Central banks in Europe
have been first movers in this easing cycle, with Sweden and
Switzerland cutting rates in May and March, respectively.       
    
    SMALL CAPS TURNING A CORNER
    Small caps are seen as one of the most likely winners of
rate cuts in Europe. These stocks have lagged their larger
counterparts since the ECB began jacking up rates in July 2022.
    But now Amundi, Europe's biggest money manager, and other
investors see scope for a rebalancing in their favour.
    "As an asset class, small cap has been suffering quite a bit
from rates going up everywhere in the world," said Fabio Di
Giansante head of large-cap European equity at Amundi. "Often
they are leveraged companies and they need to pay finance while
the mid caps and large caps have tons of cash and they can
access the debt market quite easily". 
    For Goldman Sachs, European small caps represent the
"obvious cyclical and rate-sensitive slice of the market which
continues to lag the rally". They have already started to
outperform.
    Swiss bank UBS suggests going long UK small and mid caps,
citing recent tax cuts, upcoming rate cuts and the potential for
further fiscal spending and EU alignment as reasons.    
        
    RATE-CUT LOVING SECTORS
    Utilities  .SX6P  and real estate  .SX86P  have been two
clear losers of a high-rate environment. But some portfolio
managers in Europe are positioning for a change in fortune.    
    Seen as a proxy to bonds because of their extreme
sensitivity to rates, utilities might also get a boost out of
bets that energy prices have bottomed out and by long-term
buying linked to their role in powering the
artificial-intelligence and electric-vehicle transitions. Cheap
valuations are another plus.
    Real estate, which tends to outperform in bond bull markets,
might be in for a breather from selling, as the factors that
threw some property markets into a deep crisis start to abate.
Lower rates might help kick-start new projects, increase asset
value and lower the cost of debt.
    "Utilities and real estate are the two worst-performing
sectors since the beginning of the year in Europe, therefore a
reverse trend post rate cuts could be likely," said Chiara
Robba, head of LDI equity at Generali Asset Management.    
    
    'I LOVE TO SQUEEZE THE SHORTS'
    Following the revival of the meme frenzy on Wall Street,
short-covering risks have come back to the fore. 
    The big retail ownership of U.S. stocks has little
read-across in Europe. But rate cuts across the old continent
could give investors a fundamental reason to buy into shorted
stocks, especially those where the main issue is debt.
    Heavily indebted trainmaker Alstom  ALSO.PA  rose nearly 30%
in May in the run-up to setting terms of a 1-billion-euro cash
call. Investors are 28% short Alstom -- the biggest bearish bet
on the STOXX, per data elaborated by Mediobanca.     
    Another top short, BT  BT.L , rose 17% on earnings day May
16, scoring its biggest surge since going public in 1984. "I
always love to squeeze the shorts  and prove them wrong ," its
CEO Allison Kirkby said. 
    Also, lower rates help M&A, making it risky to hold a
bearish bet on potential takeover targets, while the growing
role of systematic strategies and leveraged hedge funds in
setting price action could amplify volatility. 
    
    
    BANK PROFIT-TAKING
    European banks have been one of the main beneficiaries of
the rise in borrowing costs since 2022, following a decade of
low rates and squeezed margins. But strategists are turning
cooler on this sector as rates fall.
    MSCI's European banks index  .MIEU0BK00PEU  is up almost 20%
in 2024 alone, the best performing major sector in Europe.
    "Banks absolutely love rising bond yields," said Sebastian
Raedler, head of European equity strategy at Bank of America
Merrill Lynch. 
    But if rate cuts lead to lower yields, that tailwind could
fade.
    "Banks have had good earnings dynamics over the last couple
of quarters, predicated on lower risk premiums and higher bond
yields," Raedler added. "If that goes into reverse you should be
underweight banks".
    Barclays sees profit-taking in banks around ECB and Bank of
England rate cuts in the shorter term, but cheap valuations and
buybacks means it is positive on this sector in the longer term.
   

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Smaller names underperform European stocks    https://reut.rs/3RcbuRt
Utilities and Real Estate    https://tmsnrt.rs/4bLmHAB
Europe's most shorted stocks    https://reut.rs/3yI96vk
Bank and bonds    https://tmsnrt.rs/4aNKmz1
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Reporting by Danilo Masoni in Milan, and Samuel Indyk and Lucy
Raitano in London; Editing by Amanda Cooper and Rod Nickel)
 ((Danilo.Masoni@TR.com; Reuters Messaging:
danilo.masoni.thomsonreuters.com@reuters.net))