Investment opportunities among rising yields and continuing growth (2/2)
Be opportunistic in equity investments!
The trifecta of strong composite leading indicators, positive economic surprises reaching historically very high levels and earnings revisions returning into positive territory for the first time since 2011 allowed stock markets to register solid gains over the first half of the year. Air is getting thinner with these drivers losing impetus. Coupled with relatively stretched valuations, these are factors that will weigh on equities on coming months. We believe that most of this year’s expected gains have already been achieved.
Thanks to the abundance of liquidity, easy monetary conditions and cautious positioning of investors after years of heavy flows into bonds but none, on a net basis, towards equities, downside risks are limited. They are also limited by the underlying healthy condition of the world economy. All in all, we expect a period of consolidation, which could lead to a return to the 200-day moving average area, before the next phase of positive momentum starts, later in the year.
The medium-term trend is up, thanks to further earnings progression potential in 2018, accompanied by the return of multiple expansion, itself driven by fund inflows from other assets.
With such a roadmap, investors should look for:
- Taking some profits on several non-cyclical sectors or stocks with sizeable gains;
- Increasingly pay attention to their purchase prices;
- Taking advantage of volatility, or, in other words, be opportunistic!
EU domestic demand: a must have exposure
• Above trend growth thanks to domestic demand
The euro zone is firing on all cylinders, at last! And for once, it is domestic demand that is the strongest driver of growth, particularly consumption. Favourable expectations for the job market and wages allow expecting consumption to remain lastingly the main engine of growth. Foreigners are coming back!
• Solid EPS prospects
A small improvement in sales and margins has a significant impact on the bottom line, due to the high level of fixed costs. Thanks to this strong operating leverage, we see significant room for above average earnings growth. In addition, strongly positive base effects are expected for financials. Share buybacks will also contribute to this solid earnings outlook.
• Best plays
The most appropriate way to get exposed to the favourable winds blowing on the euro area economy is to invest in financials, the media sector, in infrastructure spending beneficiaries, commercial services, telecoms and food retailing.
• ECB on course to reduce accommodation progressively
We expect the first rate hike to occur only in the second half of 2018. The ECB will therefore keep a supportive policy stance.
Energy, a timely buy
• Back to the starting point
Just prior to the November 30 announcement of the first oil production cut since 2008, the oil price had closed around USD 46. This is where it has now come back, despite the recent renewal for 18 months of the agreement. A recovery in Libyan and Nigerian production, together with strong US production and new rises in floating storage are the main causes.
• Rebalancing is slow but remains nevertheless our core scenario
It will take longer for inventories to return to their 5-year average but demand is expected to rise, compliance with the agreement is expected to be good and US output should decelerate as a result of a decline in rig additions due to cost inflation. Over time, the Brent oil price should rise towards the higher part of a USD 50-60 range.
• Positive on energy stocks
Discipline in capital expenditure and an expected rise in the oil price will improve substantially free cash flow generation. This will support rising dividends, whose yields are already among the most attractive. Valuations are relatively attractive.
Have core investiments in secular growth
• The scarcity effect.
Since the GFC – Global Financial Crisis – growth has been anaemic and is expected to remain below its average for the period 1987-2007 because of factors such as excessive indebtedness, demography and changing lifestyles. Sectors or themes that can display above average earnings growth should be core holdings in portfolios and merit a substantial premium to the rest of the market.
• Healthcare is a secular growth sector
Healthcare is a secular growth story by excellence. This is based on the graying of society in both developed and emerging countries and high levels of innovation, which result in high barriers of entry. Dividends are high and sustainable.
• Technology is a secular growth sector.
Low growth means difficult pricing power and requires companies to improve their competitiveness. This goes through automation, the use of AI, of the cloud… After the recent strong returns, paying attention to purchase prices is required.
• Other secular growth opportunities:
Beyond looking at sectors, there are several structural growth stories, such as water, whose demand outgrows supply as several countries reach more developed stages of development, security, particularly cybersecurity, emerging market consumption, as personal incomes rise and energy efficiency.