Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Alexander Fitzalan Howard, portfolio manager, JPMorgan European Investment Trust.
In the second quarter of 2015, 75% of European companies beat analysts’ sales estimates, while the same proportion either matched or beat profit forecasts. That’s an improvement on the first quarter, which shows that momentum is on their side. Yields are lower than in the recent past, but that’s a good sign – broadly speaking, higher yields have tended to be associated with periods of crisis.
Market valuations could rise from here without looking expensive, and investors should see growth in both earnings and dividends. Following the European Central Bank’s Asset Quality Review, banks have restructured their balance sheets and are much better capitalised. They are leaner too – they have got rid of non-core assets and improved both profitability and cash flows. Many of the banks that received bailouts now have the approval of the regulators to restart paying dividends.
How might rising interest rates affect dividend-paying stocks? If you split the market into defensive, cyclical and financial stocks, defensive stocks have historically underperformed when rates rise as investors seek growth in cyclicals. Financials, meanwhile, tend to do well. This trend dovetails with our expectation that financials will directly benefit from rising rates, as higher rates ultimately help to improve their net interest margins.
In the financial subsectors of insurance, real estate and diversified financials, we see promising dividend potential and fundamental strength. Investing in financials is one of the best ways to benefit from the effects of quantitative easing (QE).
We saw this play out in the US – and relative to the size of its stockmarket, the QE operation in Europe is equivalent in size to all three US QE programmes combined, so it’s a big influence.
Insurers have provided a generous source of income recently, as extraordinarily low interest rates limited the amount of business they have been able to write, which in turn limited the amount of capital they needed to hold against that business, and gave them an incentive to repay that capital to shareholders.
Insurance company Munich Re (Dax: MUV2), for example, is beating expectations. The low rate environment haspushed it to cut costs at its underwriting operations, helping it to become much leaner. The company is poised to regain profitability as rates go up.
Telecommunications is another sector where investors can find several opportunities. Historically the sector was comprised of highly geared, debt-laden companies. But in the last few years, low borrowing costs have allowed many of these companies to refinance and reduce debt levels. This has helped to strengthen their balance sheets and build stronger capital positions.
Take Proximus (Brussels: PROX), formerly Belgacom, Belgium’s largest telecoms company. It offers a 4.3% dividend yield backed by sound fundamentals and there’s strong upside for the company – smartphone penetration in Belgium is limited relative to other European countries.
While the energy sector has struggled amid falling oil prices, investors can play the flipside of this trade by investing in the beneficiaries of lower oil input prices – such as the transport sector and mail firms, like Belgium’s B Post (Brussels: BPOST). Although letter mail volumes are falling, mail firms are benefiting from an uptick in their parcels business from online shopping. Lower oil prices mean lower transport costs, bolstering their bottom lines.