Playing the European recovery in Consumer Discretionary and Banks
After a challenging period (2011–15), European businesses have seen a pick-up in profits since mid-2016. This was driven by a stronger global trade, the eurozone economic recovery and accommodative monetary conditions.
The recent economic data has been encouraging with the European Commission’s economic sentiment indicator rising to a decade high, along with an all-round improvement across sectors and countries. Given assumptions of a gradual rise in inflation and long-term interest rates, we expect the European Central Bank (ECB) to maintain an accommodative monetary policy stance, and do not anticipate a cut in ECB’s asset purchases before 2018.
In that context, we believe that the Consumer Discretionary (high return on equity, appealing valuations and relatively better earnings growth) and Financials (prefer European banks due to their attractive valuation and positive earnings outlook) sectors are attractively positioned to benefit from the economic improvement.
The Consumer Discretionary sector is likely to witness an increase in household spending, owing to the declining unemployment rate, low interest rates and weak oil prices (SGPB strategy team expects Brent to stay in the USD 50-55 range). Further, June consumer confidence rose to its highest level since the global financial crisis and households reported an increased willingness to make major purchases in the next twelve months.
The European banks have seen a meaningful progress on de-risking of balance sheets and capitalisation since 2007 as average Tier I ratio rose to 13.5% in FY16 from 8.2% in FY07.
Further, concerns over a bad loan crisis have eased with the EUR 17 bn bailout of two Italian banks in June and consolidation is visible in the sector. We believe that the economic recovery would drive private credit growth while higher rates would support bank profitability.
We present a basket of stocks in the Consumer Discretionary and Financials sectors that are likely to benefit from the Eurozone economic recovery.
Data & recommendations as of 21 August, 2017 close
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