European espresso: ECB interest rate cut ushers in a new era for European stock pickers
As part of our Espresso series, providing an expert blend of views on European equities, Portfolio Manager Jamie Ross discusses the European Central Bank's decision to lower interest rates for the second time in 2024.
3 minute watch
Key takeaways:
- The ECB’s second interest rate cut, along with the Bank of England’s own cut in August, marks the start of a new era for both monetary policy and investment markets.
- Although we are still seeing mixed economic signals, we believe it is a good time to think about what could perform well in an environment of falling interest rates.
- Each interest rate era favours different parts of the market. Whereas banks, retail and technology have done well in the most recent period of higher interest rates, we believe that cuts create opportunities within other sectors that have lagged, such as real estate, utilities and telcos.
Today (at the time of filming on 12 September 2024), we have had a 25-basis point (bp) rate cut from the ECB (European Central Bank). Inevitably now the debate will move on to what happens at the next US Federal Reserve meeting in September, and an obsession about whether it is going to be 25 bps or 50.
We would like to take a step back here and have a think about the bigger picture. For us, we will look over the last 20 years, and we have seen three distinct interest rate periods. So firstly from 2005 to mid-2008 we saw a period of rates up. Then we saw this very prolonged period of ‘rates down, zero interest rate policy (ZIRP)’ environment from mid-2008 to 2022. Then we had the return of inflation, and people assuming that rates would go up, and then rates going up. That’s really been the three distinct periods.
Now, we are entering the fourth. Rates have peaked in the US and Europe. And although there are mixed economic signals, recent jobs weakness in the US for example, inflation is coming down, with services inflation proving a little bit sticky. But it is now right to price in significant cuts in Europe and the US. So we need to think about what would perform well in this environment.
Each of those periods I have mentioned has had very distinct differences, in the sectors, the stocks and the style leadership, in those market environments. The most recent market environment of increasing rates and the return of inflation has seen – as you would expect – the outperformance of banks, retail and, to a certain extent, technology (not quite so expected in that environment). And the areas that have underperformed have been utilities, real estate and telcos (telecommunications). It is really that latter set of sectors that we are looking for opportunities.
And over the last few months on the (European equities) desk we have found a number of esoteric stock-specific investments within those sectors. In particular, we have looked at undervalued real estate businesses, with a skew to Germany, and to post-Brexit UK. We have seen investments in more defensive infrastructure, like telcos businesses, and electricity grids has been another area of focus, where growth, returns and valuation, to us, look attractive. We need to make sure with our actions today that we do well in the next environment that we face now.
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Basis point: 1 basis point equals 0.01%.
Inflation: The rate at which the prices of goods and services are rising in an economy. The Consumer Price Index (CPI) and Retail Price Index (RPI) are two common measures.
Monetary policy: The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money. Monetary stimulus refers to a central bank increasing the supply of money and lowering borrowing costs. Monetary tightening refers to central bank activity aimed at curbing inflation and slowing down growth in the economy by raising interest rates and reducing the supply of money.
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3 minute watch
Key takeaways:
- The ECB’s second interest rate cut, along with the Bank of England’s own cut in August, marks the start of a new era for both monetary policy and investment markets.
- Although we are still seeing mixed economic signals, we believe it is a good time to think about what could perform well in an environment of falling interest rates.
- Each interest rate era favours different parts of the market. Whereas banks, retail and technology have done well in the most recent period of higher interest rates, we believe that cuts create opportunities within other sectors that have lagged, such as real estate, utilities and telcos.