European Equity Dividend Scorecard For Defensive Investors

European equity investors should seek safety in defensive stocks ahead of a month of “monetary madness” according to an Equity Strategy research note from Deutsche Bank .

Monetary policy, a key driver of equity markets since the end of the financial crisis, is set to go into overdrive during December. The ECB is likely to announce further easing measures on December 3, November’s non-farm payrolls report (a key determinant of the Fed’s next policy steps) comes out on December 4 and the Fed is then likely to hike interest rates for the first time since 2006 on December 16.

European equity investors should adopt a defensive stance

Deutsche Bank believes that the ECB is now doing what it can to facilitate a December Fed lift-off and prevent the rate hike from having an adverse effect on European economies. Assuming that the Fed does indeed decide to increase in December, Deutsche Bank expects to see a 5% to 10% correction in global equity markets.

However, the bank’s economists expect the ECB to counter the Fed’s move with a six-month extension of its QE program as well as a 10bps cut to its policy rates. Analysts see a 10% upside for European equities by year-end 2016 as a result.

To play this trend, Deutsche Bank recommends that European equity investors take a defensive stance, buying health care, which looks well-placed to weather a Fed-induced market correction while avoiding telecoms, consumer staples and utilities. Assuming markets rally following the correction, Deutsche Bank likes banks and cyclicals, both of which the bank believes will outperform during the next 12 months.

On health care:

“Health care: we want to focus on sectors that are defensive, export-focused (to benefit from a weaker euro) and have significant US exposure (to benefit from a stronger dollar). Health care fits the bill: the sector ranks top on our European defensiveness scorecard (based on 10-year net income volatility, 10-year return volatility, beta with the equity market and correlation with economic lead indicators), derives 80% of sales from outside Continental Europe (compared to 55% for the market) and has 35% sales exposure to the US (compared to 15% for the market). On our valuation scorecard, health care is the best ranking defensive sector after utilities, relative EPS has continued to be revised up, our analysts highlight that concerns about patent expiries have abated and our US strategists point out that health care will benefit from ageing and increasing efforts to treat clinical conditions with drugs (see their report 2016 S&P EPS growth to surge to 5%, Nov 20).”

(Click on image to enlarge)

European equity health care picks

On telecoms:

“Telecoms: the sector’s fundamentals are clearly improving…However, the sector has already re-rated significantly (the P/E relative is close to a 10-year high and the relative free cash-flow yield has turned negative for the first time since 2008)…”

On consumer staples:

“…have a strong track record of low return volatility – and should benefit from a weaker currency. However, emerging market exposure is high and while the staples have reported good results in EM so far this year, we think further pressure on EM via higher US rates and lower commodity prices makes all EM plays vulnerable. Furthermore, European consumer staples appear to be priced for a significant fall in US 10-year bond yields, which is an unlikely to materialize if the Fed hikes.”

(Click on image to enlarge)

Consumer staple European equity picks to avoid

On energy and basic resources:

“…there is a risk of the oil price dropping to $30/bbl (compared with the consensus forecast of $50/bbl by end-2016). While leverage for the European energy names is not particularly high, the sector has tended to underperform during periods of rising credit spreads over the past five years…real metal prices have only just returned to their 30-year average. Furthermore, leverage among the European basic resources stocks is elevated…”

(Click on image to enlarge)

Best European equity sectors

 

European equity dividend picks

Deutsche Bank’s analysts have also put together a “European dividend scorecard,” to help European equity investors pick the best sector for sustainable dividend payouts.

Best European equity dividends