After the European Central Bank (ECB) cut interest rates for the first time in almost five years, investors in European stocks are looking for stocks that will likely do well when interest rates go down.
Analysts think that the rate cut could be the start of a recovery for sectors like utilities and small caps, as well as for stocks that have been heavily shorted, since rates have been going up and staying high. Banks have been some of the biggest winners from tightening policy, but they might now be ready to cash out their gains.
As the economy of the region improves over the next few months, more rate cuts may be possible if inflation falls quickly to the central bank’s goal of 2%.
“Typically, policy easing is supportive for European equities,” said Beata Manthey, an analyst at Citi. “Combined with an inflecting earnings picture, this should help justify some additional upside.”
The ECB’s saving rate is now 3.75%, down a quarter point from its high point of 4% on Thursday. As rates have been going down, central banks in Europe have been the first to act.
Companies with small shares are thought to be one of the most likely to benefit from lower interest rates in Europe. These stocks haven’t done as well as their bigger peers since the ECB raised rates in July 2022.
But now Amundi, Europe’s largest money manager, and other investors see a chance for things to get back to normal.
Rates have been going up all over the world, which has hurt small-cap stocks a lot, said Fabio Di Giansante, head of large-cap European equity at Amundi. “As an asset class, small cap has been suffering quite a bit from rates going up everywhere in the world, 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.”
Euro small caps are “obviously cyclical and rate-sensitive slice of the market that continues to lag the rally,” according to Goldman Sachs.
UBS says that you should buy UK small and mid-cap stocks because of recent tax and rate cuts, and potential future rate cuts, and the possibility of more government spending.
RATE-CUTTING SECTORS FOR LOVE
When rates are high, utilities and real estate are two clear winners. But some fund managers in Europe are getting ready for things to get better.
Utility companies may get a boost from bets that energy prices have hit rock bottom and from long-term buyers interested in their role in powering the moves to AI and electric vehicles. This is because utilities are very sensitive to changes in interest rates, making them a good alternative to bonds. Getting low prices is another plus.
When bonds are going up in value, real estate usually does better. People may take a break from selling real estate now that the problems that caused some markets to go into deep crisis are starting to go away. If rates go down, it could help new projects get off the ground, raise the value of assets, and lower the cost of loans.
“Utilities and real estate are the two worst-performing sectors since the beginning of the year in Europe,” said Chiara Robba, head of LDI equity at Generali Asset Management. “therefore a reverse trend post rate cuts could be likely,”
“I LOVE TO SQUEEZE THE SHORTS”
As the meme craze on Wall Street has come back to life, short-covering risks have become more important.
A lot of small investors in the U.S. own stocks, but not as many in Europe. Rate cuts across the old continent, on the other hand, could give buyers a strong reason to buy shorted stocks, especially those where debt is the main problem.
Alstom, a company that makes trains and has a lot of debt, went up almost 30% in May before setting the terms of a 1-billion-euro cash call. A study by Mediobanca shows that investors are shorting Alstom by 28%, which is the biggest bearish bet on the STOXX.
BT, another top short, rose 17% on May 16 (earnings day), which was the biggest jump since it went public in 1984. Allison Kirkby, the company’s CEO, said, “I always love to squeeze the shorts and prove them wrong,”
Rates that are lower also help mergers and acquisitions, which makes it dangerous to bet against possible takeover targets. Additionally, the growing influence of systematic strategies and leveraged hedge funds on price action could make things even more volatile.
BANKS MAKING MONEY
After ten years of low rates and thin margins, most of the money that European banks have been able to borrow has gone up since 2022. Though, as rates drop, analysts are becoming less optimistic about this area.
With an increase of almost 20% in 2024 alone, MSCI’s European banks index is the best-performing big sector in Europe.
At Bank of America Merrill Lynch, Sebastian Raedler is in charge of European stock strategy. He said, “Banks love rising bond yields.”
But that advantage might go away if rate cuts cause yields to go down.
“Banks have had good earnings dynamics over the last couple of quarters, predicated on lower risk premiums and higher bond yields,” Raedler said. “If that goes into reverse you should be underweight banks” .
With ECB and Bank of England rate cuts coming up, Barclays thinks banks will take profits in the short term. However, the bank is optimistic about the sector in the long term because of low values and buybacks. At Bank of America Merrill Lynch, Sebastian Raedler is in charge of European stock strategy. He said, “Banks love rising bond yields.”
