Rate cuts fuel hopes for stock market rally | Financial markets

The market is aimed at Europe. Following the strong revaluation of equity markets accumulated since November and the improving economic outlook shown by the most recent data, investors need more detail to realize gains. And one element is the path of interest rates, as was evident on Thursday when…

The market is aimed at Europe. Following the strong revaluation of equity markets accumulated since November and the improving economic outlook shown by the most recent data, investors need more detail to realize gains. And one element is the trajectory of interest rates, as was evident on Thursday when, following Christine Lagarde’s rate cut and subsequent press conference, European indices recorded gains of almost half a percentage point. While there are still many unanswered questions, the idea that European stocks still have some way to go has begun to gain traction in recent weeks.

Moody’s analysts reiterate that lower interest rates will help stimulate economic growth. That, combined with inflation that is cooling faster than in the US and prospects that suggest earnings will end a streak of four straight quarters of decline and rise 3% in the second quarter, sets the stage for the Stoxx 600 to set new records again . “It’s a good combination for the stock market,” says Liliya Peytavin, portfolio strategist at Goldman Sachs. The ECB followed through on its planned scenario with its first rate cut in eight years, but upward revisions to inflation indicate that, as some officials and Christine Lagarde herself have indicated in recent weeks, monetary policy will continue to ease. be restrictive. Moreover, the fear of undoing the progress of the last two years and the reluctance of the Federal Reserve to reduce the price of money limit the scope of the European institution. The good news is that for now, delaying another rate cut does not appear to be able to derail the market trend on its own.

Economic theory states that monetary easing stimulates stock markets. In addition to accelerating growth and reducing the rate at which future earnings are booked (which has a particular impact on industries such as technology), this reduces the cost of financing. Due to the fact that you have to pay less on debts, companies’ ability to increase profits increases. Since the 1980s, European stocks have risen 2% per month since the Fed cut rates, double the return for any month, according to Goldman Sachs calculations. These promotions extend to 6% for six months and 10% for the next 12 months. Growth a year later will typically be much stronger if it is accompanied by a strong economy.

Unlike what happened in the last two decades, this time the rate cut is not due to a slowing economy, but rather a reaction to slowing prices. “The health of all these stars makes us think now may be the time to overweight the European stock market,” says Thomas Zlowodsky, strategist at Oddo BHF. In addition to expectations generated by monetary policy flexibility, Ignacio Cantos, director of Atl Capital, remembers that for stock markets to continue their upward trend, it is important for companies to increase profits.

ideal period

UBS, which in its latest reports confirmed the possibility of leadership of the European stock market, reaffirms its preference for shares of the Old Continent. The Swiss body believes the region is entering an ideal period now that the ECB is starting to cut rates, the economy is improving and European listed companies are undervalued compared to their US counterparts. The company gives upside potential for European equities of 2% to 3% in the short term.

However, as analysts noted, the ECB president moderated his spirit and refused to commit in advance to any specific rate path. Chris Iggo, chief investment officer at AXA IM, highlights that to achieve the 2% target, real rates would likely need to be in the range of 3-4% in the US and 2-3% in the eurozone. Although inflation has slowed, the expert warns that it is still significantly higher than the average level for the period 2010-2020. “Since the 2008-2009 crisis, disinflation has been driven by globalization, shrinking balance sheets and the impact of technology on the cost of goods and services. To return to those days, we will need a favorable combination of lower commodity prices, greater penetration of cheap imports and possibly higher unemployment,” he points out. That is, the exact opposite of the current scenario, in which geopolitical risks and protectionist trade policies set the course and stop the decline in prices.

In line with market consensus, which calls for a maximum of two more cuts in the rest of the year, Iggo expects monetary easing to be limited. In a higher rate scenario, the expert believes it is unlikely that money will shift from cash to fixed income and equity markets. Investors with cash holdings or short-term fixed income strategies benefit from interest income without taking on much risk and keeping volatility under control. “It won’t be easy to get out of cash. A year ago, it was expected that there might be a wave of flows from the money market into fixed income and equities as central banks encouraged the idea of ​​deep cuts,” he recalls. Barring this scenario, AXA IM argues that as long as central banks do not force a recession to achieve their inflation targets, the stock market and high-yield debt remain attractive options. “The market has rewarded risk-takers and the macroeconomic context appears to continue to do so,” he stresses.

Natalia Aguirre, director of research at Renta 4, is optimistic and notes that as long as the economy and results continue to hold up, rate cuts could be another catalyst to boost equity markets. The analyst firm still expects the Ibex to end the year at 12,650. That is, they give him a potential of 10.53%. Many analysts doubt that European stocks will finally outperform American stocks. While Europe’s fundamental position is starting to improve, Juan José Fernández Figares, investment director at Link Gestión, reminds us that given the leadership and weight of US tech in the stock market, it seems difficult for European stocks to outperform US stocks. “Over the medium term, Old Continent stocks will reduce the deep discount at which they trade relative to US stocks,” he emphasizes.

Fattening results

As was seen on Thursday, a day when listed Spanish banks recorded stock market gains of between 3% and 1%, muted rate cuts do not threaten the financial sector’s dominance. Since the ECB ended the era of zero rates, European banking activity has gained 62.9%, well above the 50.22% recorded by technology, and the sector is in full bloom due to the furor caused by artificial intelligence. Given that rates will remain high, analyst firms expect banks to continue to improve their results. Add to this the drums of banking consolidation, which have returned to the fore following the takeover of BBVA Sabadell and statements by French President Emmanuel Macron encouraging mergers of major European banks to strengthen EU financial integration.

While banks remain in good spirits, buoyed by rates and expectations of increased credit demand in the midst of Europe’s recovery, Antonio Castelo, an analyst at iBroker, notes that monetary assistance should benefit highly indebted sectors that are forced to make significant investments to develop of its activities. This group includes renewable energy companies such as Solaria and Acciona Energía, as well as infrastructure managers (Cellnex or Red Eléctrica) and SOCIMI. In addition to the new tariff scenario, these businesses are greatly benefited by the growth of data centers, which consume a lot of energy and require real estate to locate. At the same time, the expert identifies those businesses in which interest rates are the determining factors in their valuation. That is, technology companies, a significant portion of whose valuations are based on revenue forecasts, lose value in a rising rate scenario. Rounding out the sectors benefiting from monetary policy flexibility are leisure and tourism. Lower inflation helps increase disposable income and makes consumers feel more confident about spending.

However, all that glitters is not gold, and experts remind that there are many more factors that could send markets crashing. While geopolitical risk has become a buying opportunity in recent months, as Kantos notes, iBroker is mindful that geostrategy can move markets on its own, regardless of macroeconomics and company fundamentals. In addition to two wars ravaging the planet and demonstrating their enormous impact on commodity prices, experts point to rising trade tensions between the US and China as the US election approaches. Doubts generated by US policy and fears that things will go wrong have accelerated activity in the debt market, with euro issuances hitting a record in the first quarter, even surpassing activity recorded during the zero-rate era. Aside from geopolitics, Aguirre points to the main threats being that inflation refuses to continue falling and therefore prevents rates from being cut, that the cycle deflates too much in the US or fails to recover in Europe, and that this ultimately impacts business results. .

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