Europe: Carmakers Are Out, Banks Are In

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For several years following the financial crisis, Europe’s economy was stuck in neutral. But those days are over. The continent is currently in the midst of a growth cycle, and astute investors have profited handsomely. The improving economy and declining euro made auto stocks attractive for months. But that trade has just about run its course, especially as the sharp decline in the euro seems to have halted—at least for the time being. What sector is poised to take the baton? According to Credit Suisse, it’s financial institutions.   Auto stocks started looking like a good buy when oil prices began falling, which boosted demand for vehicle sales. Then the growth outlook for the Eurozone economy became more optimistic, and autos looked even better. Indeed, Credit Suisse projects that the economy grew at a better-than-expected annualized rate of 2.5 percent in first quarter. What’s more, the export-heavy auto sector has benefited from the relative weakness of the euro, which has fallen 18 percent over the past year vis-à-vis the powerful dollar. Even German automakers have been reporting strong results, despite the slowdown in China, an important export market.   The party may not be over for investors in autos, but it’s certainly winding down. Credit Suisse recently halved its overweight in the sector, citing as a key reason the fact that the euro is projected to enter a period of relative stability. (Recent weakness in U.S. unemployment, retail sales and manufacturing data have stopped the dollar’s rise—at least temporarily.) European auto stocks tend to underperform when the euro strengthens because the sector is heavily dependent on exports. German auto manufacturers in particular will likely feel the pain of the stronger euro since they’re already hurting from weaker Chinese demand. Sales of foreign auto brands in China only rose 2 percent in the first quarter, compared with a 38 percent increase for domestic brands. BMW, for instance, is cutting prices in response. Credit Suisse forecasts that European car sales will slow from the 10 percent they posted in the first quarter, and will grow only 3 percent on the year as a whole.   At the same time, Credit Suisse is boosting its view on banks, increasing its overweight from 10 to 12 percent. That’s because the financial sector tends to outperform when the economy improves and the currency strengthens. Indeed, recent PMI manufacturing data in Europe has been better than expected, and the euro has risen 7.5 percent since April 13. Also, the European Central Bank’s lending survey points to an improvement both in borrowers’ demand for credit and banks’ willingness to lend. Corporate demand for loans is the highest it’s been since 2007. Bank results are also particularly sensitive to the PMI manufacturing figure, which Credit Suisse forecasts could rise another 4 to 6 points from its April level of 52.0.   Credit Suisse favors retail over investment banks because they offer a higher return on equity. Retail banks in the U.K. and Sweden, for example, have RoEs of between 13 and 17 percent. Also, Eurozone housing markets are looking better and more loan growth is likely on the way. Finally, Internet banking is offering retail banks big opportunities to improve margins, since the cost-to-income ratio for online services is 30 percent, compared with 50 percent for brick and mortar banks. “Retail banks,” says Credit Suisse, “are in a fundamentally strong position.”



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