Open-ended QE to lift eurozone equities to fresh highs
The European Central Bank's quantitative easing announcement is a significant move that has positive implications for eurozone equities.
The European Central Bank (ECB) may have arrived late at the quantitative easing (QE) party but its appearance is still causing a stir. The ECB has announced asset purchases of €60 billion per month from March 2015 until September 2016, expanding its balance sheet by €1.1 trillion. The programme goes even further than this, however, in that it has been left open-ended and will continue until inflation moves towards 2%. There has been scepticism voiced in various quarters about the likely effectiveness of the ECB’s QE programme. In our view, the announcement of QE represents a bold and significant step for Europe, particularly in terms of the implications for asset prices.
"The European Central Bank may have arrived late at the quantitative easing party but its appearance is still causing a stir."
Experience of other regions demonstrates power of QE
Other major central banks – including the Federal Reserve (Fed), Bank of England and Bank of Japan – have engaged in quantitative easing already and we can draw a potent message from their experiences. QE has had a mixed impact in terms of propelling economies to stronger growth, but in all instances it has provided significant positive impetus for asset prices and especially for equities. The US stockmarket in particular has enjoyed outsized gains from the Fed’s various QE programmes and we would expect a similarly strong boost for the eurozone equity market.
The arrival of sovereign bond buying onto the eurozone equity scene is combined with a number of other factors that should prove supportive for share prices. The euro had already weakened substantially versus the dollar in anticipation of QE but the size of the programme looks set to drive further weakness. Moreover, the dollar is likely to strengthen as the Fed prepares the ground for an interest rate hike. The sharp fall in the oil price will also be supportive for equities, other than energy stocks, while bond yields are continuing to see extreme compression. Taken together, these factors add up to a solid stimulus for the eurozone and are supportive for corporate earnings growth.
Winners and losers from QE
While quantitative easing is likely to lead to an across the board re-rating of eurozone equities, some sectors will benefit more than others. The greatest benefit will likely be felt by those firms at the cyclical, more economically-sensitive, end of the spectrum. We see the consumer discretionary sector overall as still being attractively valued even after recent good performance. In particular, we think the auto components sub-sector is well-placed, although the automakers themselves may still suffer from competition from emerging market firms. The media sub-sector is another that could see strong support from QE, especially combined with the lower oil price which is resulting in a boost to consumers’ disposable incomes. Elsewhere, we think the industrials and chemicals sectors should fare well amid lower input costs. Firms with overseas earnings could do particularly well thanks to the stronger dollar.
The above are all examples of cyclical areas of the market that should outperform. However, there are some more defensive sectors that can perform strongly. The telecommunications sector is one that is trading on a cheap valuation overall and that could re-rate with the support of QE. Telecoms firms in general are highly leveraged so are among the biggest gainers from the current yield compression and also are not reliant on achieving ambitious growth assumptions. Some healthcare firms could also be among the top beneficiaries as QE lends its support to higher quality, higher growth areas of the market.
By contrast, the financials sector is likely to experience only a muted benefit from QE. Insurers in particular are not well-placed given that their dividend capacities will be impacted by declining interest rates.
Greece poses limited risk
Another noteworthy recent event in the eurozone has been the Greek election, won by the left-wing, anti-austerity Syriza party. It is important to recognise that anti-austerity does not mean anti-euro. Neither the Greek people nor their new government want to exit the single currency, and nor is it in the interests of other eurozone members to see them leave. However, eurozone finance ministers appear to be taking a hard line as regards any kind of debt relief being offered. A possible compromise is that some of the terms and conditions of the existing bailout programme could be altered.
We therefore see ‘Grexit’ as an unlikely scenario. Even if it did come to pass, however, it would be less of a shock to the eurozone than if it had occurred at the peak of the sovereign debt crisis three years ago. The majority of Greece’s sovereign debt is held by supranational agencies rather than by the private sector, thus limiting the impact of any default. In addition, the Greek stockmarket has little direct exposure to the broader eurozone market. Our view is that the ECB’s decision to launch QE now takes the sting out of any uncertainty as Greece’s bailout renegotiations unfold.
‘Do whatever it takes’ comes to fruition
In all, we see the recent QE announcement by the ECB as being a clear fulfilment of Mario Draghi’s summer 2012 pledge to ‘do whatever it takes’. There has already been an upturn in leading indicators recently, notably the German ZEW and Ifo sentiment surveys, as lower oil prices and a weaker euro feed through. We can now add the broad-based stimulus offered by QE to the tailwind lifting eurozone equities. Given the impact QE has had in other regions, there is the clear potential for eurozone equities to re-rate in absolute terms and relative to other asset classes.