Which industries and values will benefit most from a “new horizon” of lower rates?
A decline was considered inevitable, and the European Central Bank (ECB) followed this script. Last Thursday, the institution cut interest rates by 25 basis points as the market softened. What will happen in the second half of 2024 is still in question. ECB President Christine Lagarde on Thursday avoided giving clues about next steps in monetary policy and was reluctant to “commit in advance to any particular rate path.” According to Bloomberg, the market is forecasting a second contraction in September.
What can investors expect now that Europe is finally on the path to cuts? For conservatives who invest heavily in fixed income, falling rates are good because when the ECB lowers the price of money, the price of bonds rises. In terms of the riskiest investor most exposed to stocks, in general terms, The rate cut is expected to have a positive impact on stock markets.: Companies will be able to finance themselves more cheaply and increase their profits, which should boost their share prices. In any case, it should also be noted that the European stock market did not always react well to rate cuts, as in some cases they coincided with major crises.
Which industries and specific securities would benefit most from a decline in the price of money? According to Ignacio Cantos, Chief Investment Officer of ATL Capital, from now on “The most profitable sectors may be utilities, both classic and renewable, that they are more in debt and more punished; also sector concessions could benefit from debt reduction and benchmarking against sector returns. And finally, according to Kantos, all of these highly leveraged industries “will be among the most stimulated by the new monetary path.”
“The renewable energy sector will be one of the most profitable in a lower rate scenario,” explains Eduardo Imedio of Renta 4 Banco, just as tightening financial conditions have been dragging down prices in the sector over the past two years. “Rising rates that began in March 2022 in the US and July 2022 in Europe led to higher discount rates, which led to a decrease in the present value of future cash flows from both new and existing capacity. Given that renewable energy projects typically have a long investment horizon (30-40 years), the impact of the higher discount rate was particularly pronounced,” explains the analyst. In addition, rising interest rates have “increased the cost of financing for new projected capacity, projects that typically require a high degree of investment,” adds Imedio.
If interest rates begin to fall, this will mean that these effects will begin to reverse. becomes a tailwind for prices across the sector. “A lower interest rate environment will lower the cost of financing new projects and increase the profitability of existing ones, increasing the attractiveness of investment in renewable energy, a sector that remains extremely dynamic due to countries’ needs for energy independence and demand for alternatives to natural gas,” explains the expert. Rent 4″. Imedio highlights values such as Activate energywho “could answer very well The company “has extensive diversification both geographically, with a presence on all five continents, and technologically, investing in all types of renewable assets (solar, wind, hydro, biomass and storage).” This diversification makes the company “attractive to benefit from lower interest rates while remaining protected from disruptions in certain regions or technologies.”
Diego Morin, sales analyst at IG, also notes that “the first rate cut by the ECB will bring a little breath fresh air into the renewable energy sector (Activate energy, Solarium, Grenergy…), after a difficult journey they had to go through in the face of tight monetary policy, which brought their prices down from their 2022 highs.” “We have to take into account,” adds Morin, “that renewable energy projects and/or investments usually have a long-term period, so we see cash flows being burdened”; Consequently, “we will see the ECB’s ability to provide room for rate cuts as the inflation pressure scenario opens up, but for now, financing costs may give the sector breathing space and profitability will improve,” he adds.
Morin also notes that another company that could see “some relief” is Cellnex Telecom because “its financing costs have increased in the current tariff environment.”“, he explains. On the negative side, indicates that “I would reduce my influence on the banking sector. due to a possible increase in default rates (already happening in the US), although we will see how inflationary pressures affect.
Also from Renta 4 Banco, Javier Diaz Izquierdo notes that “in general terms real estate should benefit from lower rates, although this would mean the end of rising yields in valuations. Likewise, there is greater emphasis on potential future refinancing in the traditionally leveraged sector.” From an operational point of view, “the sector will continue to perform well, driven by tight demand in the case of housing and economic growth, employment and inflation in the case of the tertiary sector,” the analyst elaborates. Falling rates give investors the confidence they need to return to SOCIMI.
ECB-initiated easing is “likely to stabilize at close to 2% over the medium term, much higher than the previous decade,” Citigroup strategists warn. Following Thursday’s cut, the ECB’s interest rate stands at 4.25%, down from the previous 4.5%, which was a record level. “While the focus now is on cuts, the implications of structurally higher inflation and rates could be just as significant for European equities,” they explain, adding that “while macroeconomic volatility may weigh on economic growth, “This environment could still be relatively supportive for European equities.”.
Slow way
The expected first rate cut has already happened, but rates remain high and the next cut will take time, Lagarde showed at Thursday’s meeting. This suggests the change will not be “material” to the performance of listed companies, at least in the short term. That’s what Victor Alvarez, head of variable income at Tressis, says, acknowledging that a lower rate improves credit flow and represents little relief for debt balances. “But we insist that 25 basis points will not change the forecast much.”
Alvarez agrees with the rest of the experts and believes that the sectors that will benefit most from this decline will be the most leveraged: “Utilities, especially regulated businesses such as electrical; real estate, both real estate and concessions in the USA, and even in some basic consumption industries, see food or household goods.”
So Tressis’ head of variable income goes further and points out that by discounting future flows at a lower rate, “there are several sectors that are not benefiting from their valuations.” “A good example is technology or communications companies, companies with significant growth that base their valuation on future cash flows. And if we move to the second and third derivatives, a lower rate implies greater flexibility in lending and greater ability to invest. likely to improve the prospects of companies such as Cellnex or Merlin Properties.”
Only banking is left out of the equation, as financial institutions’ core business is directly dependent on interest rates, “so it is likely that they will no longer be as stellar as they have been in the past two years.”
Roberto Scholtes, head of strategy at Singular Bank, shares the same view and believes that “the effect of rate cuts on equity markets will be relatively limited.” Another reason is that companies have already done most of their homework: “Companies have generally been deleveraging and refinancing (at fixed rates and for longer terms) in recent years, and it is also likely that the ECB may need to a few blocks to simply return to neutral policy.
He also points to real estate as the sector that benefits most from this context and names companies such as Merlin, Colonial, Aedas, Naynor, Vonovia or Unibale, who will be among the winners “both due to appraisals and the resumption of mortgage lending.”
“And although less than in the past, also electric, especially those with more ambitious investment plans (such as Iberdrola, ENEL or RWE). Another market segment that is good for this is small hats, as a rule, more domestic, cyclical and indebted (and at floating rates in a shorter period of time) than large countries,” the expert concludes.