When European Central Bank (ECB) President Mario Draghi stunned markets last week with a bazooka that exceeded market expectations, I said investors should buy European stocks as a result.
The announcement that the ECB will buy non-financial corporate bonds is a boon for the eurozone's big companies. The central bank has not forgotten banks either: it will offer four long-term refinancing operations with rates at zero in the worst case and in which it will pay banks to get the money, in the best case.
Some critics have expressed skepticism that this will work for the real economy. What is to stop companies from borrowing money and buying back shares rather than investing in expansion? While this would indeed be bad for the real economy, it would still be good for stocks. So they are still a buy.
Equity strategists at Bank of America Merrill Lynch are of the same view. They have operated a series of upgrades of their views on European stocks following the ECB's measures.
The measures have highlighted three themes that are developing in the European stock markets, according to the analysts: credit spreads between various bonds are narrowing, expectations that inflation will keep falling will find a floor, and there will be a continued emphasis on dividend yield for investors in a world where yields across asset classes remain low.
The European auto sector is the most important one to watch for investors, as it is well situated to benefit from all three themes. Car manufacturing companies will be big beneficiaries narrowing credit spreads, and they are also highly correlated to inflation expectations.
The sector is relatively cheap, too. It is trading well below its 52-week average and its relative price/earnings ratio (the sector's PE ratio divided by that of the market) is at 10-year lows, the analysts said.
They upgraded the sector to neutral from underweight, with the caveat that the companies that are exposed to China for their exports (they don't give names, but I would mention Germany's luxury car makers, such as BMW (BAMXY) and Daimler (DDAIF)) are likely to face more turbulence than those focused on European sales. Again they don't give names, but I believe Volkswagen (VLKAY) in Germany and France's Renault (RNLSY) and Peugeot-Citroen (PEUGY) to be the main ones.
Autos are ranking high in their preferences when it comes to dividends, too. In a ranking of European stock sectors the analysts compiled taking into account dividend yield, dividend cover and two-year growth prospects, autos came third in Europe, after banks and telecommunications companies.
Of course, investors should still take into account company-specific issue. As the latest news about Volkswagen demonstrates, the dust is far from having settled on the emissions scandal; institutional investors in the German carmaker have filed a $3.61 billion lawsuit, accusing it of breaching its capital markets duty.
While this is bad news for the automaker, the sector as a whole is likely to benefit tremendously from the ECB's announcements. It is worth at least an inquisitive look.
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