The decline was considered certain and the European Central Bank (ECB) followed the script. Last Thursday, the institution cut interest rates by 25 basis points, as the market discounted. What happens in the second half of 2024 is up in the air. The president of the ECB, Christine Lagarde, avoided giving clues on Thursday about the next steps in monetary policy, and she did not want to “commit in advance to any specific rate path.” The market predicts a second cut in the month of September, according to Bloomberg.
What can the investor expect from now on, when Europe has finally set its foot on the path of cuts? For conservatives, those who are heavily invested in fixed income, the drop in rates favors them, since when the ECB lowers the price of money, the price of bonds rises. As for the riskiest investor, the one most exposed to equities, in general terms, What is expected is that the rate cut will have a positive effect on the stock markets.: Companies will be able to finance themselves more cheaply and increase their profits, which should boost the valuation of their shares. In any case, it should also be noted that the European stock market has not always reacted well to rate cuts, since on some occasions these have coincided with major crises.
What sectors and specific securities benefit the most from cuts in the price of money? According to Ignacio Cantos, Investment Director at ATL Capital, from now on “the most benefited sectors could be utilities, both classic and renewable, that they are more in debt and have been more punished; also the sector the concessions could benefit from debt cuts and comparison with sector returns. And finally, all those industries with a high level of leverage” would be among the most driven by the new monetary path, according to Cantos.
“The renewable sector would be one of the most beneficiaries in a scenario of lower rates,” explains Eduardo Imedio, of Renta 4 Banco, in the same way that the tightening of financial conditions has been a drag on the sector’s prices during the last two years. “The rise in rates, which began in March 2022 in the US and in July 2022 in Europe, caused higher discount rates, decreasing the present value of future cash flows from both new capacity and capacity already built. Given that renewable energy projects usually have long investment horizons (30-40 years), the impact of a higher discount rate has been especially pronounced,” explains the analyst. Added to this is that the increase in interest rates “It has increased financing costs for the new projected capacity, projects that normally require a high degree of leverage on the investment to be made,” adds Imedio.
If interest rates began to fall, it would imply that these effects would begin to reverse, becoming a tailwind for the prices of the entire sector. “An environment of lower interest rates will reduce the financing costs of new projects and improve the profitability of existing ones, increasing the attractiveness of investments in renewable energy, a sector that remains tremendously dynamic due to the energy independence needs of countries and the demand for alternatives to natural gas,” explains the Renta 4 expert. Imedio highlights values such as Activate Energywho “could respond very well to a lower interest rate environment.” The company “has extensive diversification both by geography, as it is present on all five continents, and by technology, investing in all types of renewable assets (solar, wind, hydraulic, biomass and storage)”. This diversification makes the company “an attractive value to benefit from lower interest rates, while remaining protected from disruptions in specific geographies or technologies.”
Diego Morín, sales operations analyst at IG, also points out that “the first rate cut that the ECB will carry out will bring a small breath of fresh air to the renewable energy sector (Activate Energy, Solaria, Grenergy…), after the hard road they have had in the face of a high-rate monetary policy, sinking their prices from the highs of 2022.” We must take into account, adds Morín, “that renewable projects and/or investments usually have a long-term period, which is why we have seen cash flows weighed down”; therefore, “we will see the ability of the ECB to give room for rate cuts, since a scenario of inflationary pressures is opening up, but, For now, financing costs could give the sector a break and profitability would improve,” he adds.
Morín also points out that another company that could experience “some relief” is Cellnex Telecom, since “its financing costs have risen in the current rate environment“he explains. On the negative side, points out that “I would cut my exposure to the banking sector due to the possible increase in default rates (already happening in the United States), although we will also see how inflationary pressures act.
Also from Renta 4 Banco, Javier Díaz Izquierdo points out that “in general terms the real estate should benefit from the rate cut, while it would mean the end of the expansion of yields in valuations. Likewise, greater visibility is given to possible future refinancing in a traditionally leveraged sector.” From the operational point of view, “the sector will continue with good performance derived from the rigidity of demand in the case of residential, and economic growth , employment and inflation in the case of the tertiary sector,” details the analyst. The drop in rates gives the investor the certainty he needs to return to the SOCIMIs.
The easing that the ECB has initiated “will probably stabilize at levels close to 2% in the medium term, much higher than in the previous decade,” warn Citigroup strategists. After Thursday’s decrease, the ECB’s interest rate stands at 4.25%, from the previous 4.5%, which was a record level. “While attention is now focused on cuts, the implications of structurally higher inflation and rates could be just as significant for European stocks,” they explain, adding that, “although macroeconomic volatility could affect economic growth , “This environment could still be relatively favorable for European stocks.”.
A slow path
The expected first rate cut has already arrived, but rates remain at a high level and the next cuts will take time, as Lagarde showed at Thursday’s meeting. This assumes that the change is not “substantial” for the performance of the listed companies in, at least, the short term. This is what Víctor Álvarez, head of variable income at Tressis, believes, recognizing that a lower rate improves the flow of credit and represents a small relief for indebted balances. “but we insist that 25 basis points do not change the outlook much.”
Álvarez agrees with the rest of the experts and believes that the sectors that will benefit most from this drop will be the most leveraged: “Public services, especially regulated businesses such as electrical; real estate, both real estate and concessions in the US, and even some industries within basic consumption, see food or household products”.
Thus, the head of variable income at Tressis goes further and indicates that, by discounting future flows at a lower rate, “there are few sectors that do not benefit in their valuations.” “A good example is technology or communication services, companies with considerable growth that base their valuation on future cash flows. And if we go to the second and third derivative, a lower rate implies more flexibility in credit and greater ability to invest. It will probably improve the prospects of companies such as Cellnex or Merlin Properties”.
In this equation it only leaves out banking, since the main business of financial institutions depends directly on interest rates, “so it is likely that they will no longer shine like they have in the last two years.”
Roberto Scholtes, Head of Strategy at Singular Bank, shares the same opinion and believes that “the effects of the rate cuts on the stock markets will be relatively limited.” That companies already had much of their homework done is another reason: “Companies in general have been deleveraging and refinancing (at fixed rates and in longer terms) in recent years, and it is also likely that the ECB It may take several quarters simply to return to a neutral policy.
He also points out real estate as the sector that most benefits from this context, and names companies such as Merlin, Colonial, Aedas, Neinor, Vonovia or Unibail, who will be among the winners “both due to valuation and reactivation of the granting of mortgages.”
“And although less than in the past, also the electric ones, especially those that have more ambitious investment plans (such as Iberdrola, ENEL or RWE). Another segment of the market that is good for it is small caps, generally more domestic, cyclical and indebted (and at variable rates in shorter terms) than the large ones,” completes the expert.
