Why European financials might be the next safe haven asset
However rather than investing in high quality defensive companies next year, Neptune European Opportunities manager Rob Burnett, says contrary to popular belief European banks could be the next safe haven going forward.
The reason this goes massively against the grain is that since 2007 it’s fair to say that financials, both in Europe and globally, have not enjoyed the best of times. Burnett says banks have been the single biggest loser in the world of quantitative easing that followed the financial crisis, with interest rate cuts hitting both their earnings margins and profitability, leading to massive share price declines.
As a result he describes the last 10 years as a “traumatic period” for the sector and he understands investors may be cautious on it going forward. However in a market environment in which interest rates cannot go any lower, he says the prospects going forward can only be positive.
“If rates cannot go any lower than the margins of these banks will stabilise and at trough margins and tough margins, we believe that banks are one of the few sectors that could experience both an earnings expansion and a re-rating as the cost of capital rises,” he says.
“As a result it is a wonderful time to own them and they make up a large proportion of the fund at present, versus the so-called safer/defensive companies that sit in the consumer staples and healthcare sectors.
Indeed to quote Rambo, Burnett says the prospects for European financials have gone “full circle” from being hugely risky to the biggest single beneficiary of the expected interest rate rises next year.
Going the other way are the so-called bond proxies, which are equities which have bond-like qualities. Having performed well since the financial crisis, Burnett says these defensive growth companies have never been more expensive, while at the same time their growth rates are declining.
“Quality growth companies have low earnings risk, but given their high valuations in many cases, they have high price risk,” he says. “Sometimes only slight earnings disappointments are required for share prices to fall heavily, as we have seen in recent months.”
To date Burnett says the recovery in European banking stocks since the depths of February last year have been relatively modest. As a result he expects further upside from here on out, while at the same time the sector is also paying out nice dividends.
He says: “It is not uncommon to find well capitalised European banks paying dividends yielding more than 5%, trading on price-to-book multiples of 0.5-0.7 times, and price-to-earnings ratios of under 10 times. BNP Paribas and Societe Generale are good examples.
“As such, while it will take some courage on the part of investors, we think European banks, represent the deepest value play going forward, as value strategies once again come to the fore.”