"A benefit for stocks in Europe"
The European Central Bank (ECB) might cut interest rates before the Federal Reserve. Michael Barakos, a fund manager at JP Morgan Asset Management, discusses what this means for European stocks and his current investment strategy in oil multinationals' stocks.
Central banks in Sweden and Switzerland have already reduced interest rates. The ECB could follow suit, along with the Bank of England. How does this benefit European stocks?
Barakos: This will be the first time since the ECB's inception 25 years ago that it lowers rates before the Fed. This is unusual since Europeans usually look to the Fed due to its global leadership role. However, the ECB has prepared a rate cut in June, while the Fed won't be ready until at least the fourth quarter. This gives European stocks a distinct advantage.
European stocks tend to perform well when interest rates are decreasing as the economy recovers. Are you expecting another boost for the stock market with this scenario?
In this case, it's an atypical situation. Normally, interest rates fall when the economy is experiencing a disappointing growth or a recession, requiring central banks to stimulate the economy. However, with the eurozone's economy recovering, it's growing with some inflation - a "Goldilocks scenario."
What does this mean specifically?
The economy is growing, and there's some inflation. The ECB has contained inflation, possibly reacting too little initially. Moreover, consumer sentiment is recovering, and European fiscal stimulus from the EU level remains high, with funds from the Green New Deal being used. This all adds up to a favorable environment for the European economy, leading to higher corporate profits.
What are the potential risks?
The main risk from an economic standpoint is stagnation, where slow/negative growth coexists with high inflation. While it's not likely in Europe, political decision-makers could face challenges in such an environment.
What gives you confidence despite the risks?
The ECB has actively managed the inflation situation and maintained control. Additionally, the chance of a major international crisis (e.g., war in Ukraine or significant political unrest) can be considered.
The Goldilocks scenario seems very optimistic. How does this translate to European stock performance?
As lower interest rates decrease the discount rate, which is applied to future profits, higher stock prices in Europe are possible. Therefore, Barakos doesn't foresee growth stocks outperforming value stocks as the trend has been for the past six months. This could lead to value stocks outperforming growth stocks or small-cap stocks outperforming large-cap stocks.
In addition to growth and value stocks, are there any sectors that appeal to you now?
The most promising sectors are banks and energy. Although they're less attractive than a few months ago, they're still worth considering.
Banks in the eurozone have experienced significant growth in European bank stocks in the past two years, boasting impressive valuations. The European banking sector has recovered well from the global financial crisis of 15 years ago.
Allianz plays a significant role in Barakos's value fund as an example of a prominent insurer. Why is this insurer essential to your fund?
Allianz, like other insurance companies, generates stable profits and is known for its consistency in paying dividends. Barakos aims to have broad representation of these stable areas in his fund.
Your fund also features large positions in energy companies like Shell, BP, and Total. How can ESG investors consider these stocks despite their industry?
For ESG investors, these oil multinationals can still be an option. ESG considerations usually focus on the companies' climate impact, but Barakos points out that many of these firms are investing in renewable energy projects as well.
ESG is something we wholeheartedly believe in for the long term. However, the energy transition takes time - not days or even months, but years. People seemed to think the transition would happen overnight, resulting in major overvaluations, particularly in the solar and wind sectors.
And are oil company stocks still a viable investment?
Many energy stocks offer double-digit annual returns, recouping your initial investment within a few years. However, it's crucial to remember our responsibility towards the planet. Unlike with private companies, we can use our influence as investors to push for change in listed companies. They focus solely on maximizing profits and don't face accountability from investors. There's a noticeable trend towards privatization, such as in the US coal industry.
What are your thoughts on this trend?
We want to encourage more accountability from companies by affecting their voting behavior. With the transition to sustainable energy still in progress, traditional energy sources like oil and coal will remain in use for some time. Nevertheless, we see companies making efforts to improve sustainability in some aspects.
Looking at the global market, it's fairly affordable in terms of price-earnings ratio in Europe compared to the US. Does Europe have potential to catch up?
There's been a lot of talk about Europe's potential to catch up. While Europe hasn't disappeared, the European stock market has generated around 10% return per year over the last decade. It might not have been as impressive as the US, but it's better than markets like Japan or emerging markets. European luxury goods have outperformed US tech stocks. But it's also true that many US investors currently have low exposure to Europe or are not invested at all. (Interview with Michael Barakos, conducted by Stefan Schaaf)
(The interview was originally published at capital.de)
