Consumer discretionary and Financials should benefit most from the economic recovery while offering more appealing valuations
After five difficult years, European businesses saw profits begin to pick up in mid-2016, supported by stronger global trade, the eurozone economic recovery and easy financial conditions.
Recent economic data indicate strong growth. The European Commission’s economic sentiment indicator rose to a decade high, showing broad-based improvement across sectors and countries.
Given our assumption that the rise in inflation and long-term rates will remain gradual, the European Central Bank (ECB) will stay accommodative and we do not expect the central bank to cut asset purchases before 2018. We believe Consumer discretionary and Financials sectors are best positioned to benefit from economic improvement.
Consumer discretionary. Declining unemployment, low interest rates and weak oil prices – we expect Brent to stay in a $50-55 range – will support household spending in coming months. Already in June, consumer confidence rose to its highest level since the Great Financial Crisis (GFC). Households reported growing willingness to make major purchases in the coming twelve months. As a result, Consumer Discretionary firms should see profit growth outstrip that in other sectors in coming months. In addition, return on equity is high and valuations are appealing.
Financials. Since the GFC, European banks have been working hard to steadily clean up their accounts. Compared to 2007, balance sheets are sounder, solvency has improved – the average Tier 1 ratio is up from 8.2% to 13.5% last year – and sector consolidation is underway. The €17bn bailout of two Italian banks in June will ease fears of a bad loan crisis. Moreover, valuations are attractive and the outlook for earnings looks brighter. Economic recovery should continue to boost private credit growth and slightly higher rates will underpin bank profitability.