European stock traders will need to add a further variable to their investment strategies this week: how rising interest rates will affect each corner of the market.
Money markets have all but fully priced a quarter-point rate hike by the European Central Bank when it meets on Thursday, to counter inflation pressures triggered by the Iran war. With at least two rate increases priced in through year-end, investors will have to position for the uneven impact of ECB tightening across sectors and for how long they believe the hiking cycle will last.
Banks, already tracking a fourth year of gains, look obvious winners as rates climb. Energy companies, meanwhile, are shielded by floods of cash from booming oil sales. Utilities and real estate look at risk, as traditional bond proxies. Consumer-facing shares like luxury are set for strain as higher borrowing costs erode demand.
“The ECB’s rate hike in June is fully anticipated by the market, which however really wants to believe that the rise in oil prices and inflation will prove temporary,” said Roland Kaloyan, head of European equity strategy at Societe Generale SA.
An added complication for European equities is that they’re heading into a potential rate-hiking cycle at far higher valuations than the previous one, four years ago. The Stoxx Europe 600 trades at nearly 15 times forward earnings, compared to less than 12 times in 2022.
It’s highly unlikely that rates will climb as high as they did back then, but it would be prudent to be selective in sector exposure. A Goldman Sachs Group Inc. team including Guillaume Jaisson said pricer valuations leave equities vulnerable if yields grind higher.
Over at UBS Global Wealth Management, strategists including Mark Hafele said they prefer to invest in European companies benefiting from trends beyond just the rate backdrop. They cite information technology and industrials among these.
As investors brace for the ECB’s first hike since September 2023 and at least a temporary period of higher rates, here’s what to watch for on decision day:
As so often in high-inflation environments, the continent’s banks are a prime target for investors seeking to cash in on a hawkish ECB. “We’re expecting two ECB hikes in the second half of the year, so we see the banking sector as a good proxy to play higher bond yields and inflation on the stock market,” said Kevin Thozet, a member of the investment committee at Carmignac.
But, given years of outperformance, the boost for banks will likely be less pronounced than in 2022, according to Keefe, Bruyette & Woods analyst Andrew Stimpson. Lenders would begin this cycle with interest rates at much higher levels and with elevated hedging against risks. He tips Irish and Dutch banks to be relative winners, with French banks poised to benefit the least in the near term.
Insurance companies, in contrast, would be less favored as their defensive nature and function as bond proxies would likely lose attraction in a higher-yield environment.
Utilities have started to loosen their association with yield levels as the sector becomes more tied to the artificial intelligence and electrification theme.
But, as rates move higher, companies in the sector like Iberdrola SA and Engie SA will need to convince investors that their outperformance of the Stoxx 600 this year is justified and that they’re managing to deliver on expectations.
Earnings in the sector are set to climb 4.9% this year, compared with a 12% increase across the benchmark index. Barclays Plc strategists are overweight the group due to the recent tailwinds, but acknowledge rising rates as a risk.
The picture is more bleak for real estate, which already trails the market this year. Its profits are set to drop 2.1% in 2026, the only sector whose earnings are poised for a decline. It’s still highly rate-sensitive, according to the Goldman strategists, leaving it likely to remain a laggard as rates rise.
Chemicals have been battered by a protracted period of weak demand, rising expenses and global overcapacity. And just as conditions were turning more positive for these companies, with supply-chain disruptions from the war promising a short-term boost, the ECB might be about to pose another headache.
“Higher interest rates in Europe could be unhelpful for volume growth in the chemicals sector,” said Berenberg analyst Sebastian Bray. “The diversified chemicals sector should have a good second quarter on higher prices owing to Iran-conflict-induced feedstock shortages in Asia, meaning that higher rates could increase the risk of sequential deceleration.”
Autos are the worst-performing Stoxx 600 sector this year, and various inflationary factors keeping monetary policy relatively tight likely won’t help change that. Hawkish central bank policy risks “raising borrowing costs and diminishing affordability, which further caps volume growth and pricing power,” Moody’s Corp. said in a recent report.
ECB rate hikes won’t be welcomed by retailers of high-end fashion and jewelry. “Anything that impacts growth and markets negatively is not good for luxury,” said Morningstar analyst Jelena Sokolova.
From a balance-sheet perspective, Sokolova said Gucci owner Kering SA looks the most vulnerable from higher borrowing costs due to its elevated debt position.
In fact, a hawkish Federal Reserve might prove even more of an issue than rising borrowing costs in Europe. Higher US interest rates, the thinking goes, would weigh on the country’s stock market, ultimately damping American consumers’ appetite to snap up hand bags and jewelry as their behavior is much more directed by equity market wealth effects.
Industry behemoth LVMH and Kering are among luxury-good firms that derive the biggest share of their revenue from the US.
Energy is an indirect beneficiary of the higher rates scenario due to the key driver of inflation in the first place: soaring oil prices. The sector’s earnings grew 22% in the first quarter as crude rallied, giving producers scope to pay debt and reward shareholders, even if rates are climbing.
“The European oil majors have used the higher oil and gas prices levels in recent years to de-lever their balance sheets accordingly, which makes them less vulnerable to rising interest rates than in the previous rate cycle,” said Jens Zimmermann, research analyst at Gabelli Funds. “That’s why a modest interest rate increase should not significantly affect their earnings and cash flow streams.”
Meanwhile, renewables have historically lagged during tightening cycles due to the need for project financing but Zimmermann said that as long as the size of the hikes remain small, the sector should be able to cope for now.
With assistance from Henry Ren, Marton Kasnyik, Lisa Pham, Julien Ponthus, Macarena Muñoz, Isolde MacDonogh, Farah Elbahrawy and Michael Msika.
This article was generated from an automated news agency feed without modifications to text.
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