The volatility of the third quarter upset sector valuations and closed many of the opportunities we had highlighted in areas like healthcare and utilities, but at the same time opened up new ones in sectors like energy and technology, that had until now been expensive.
Consumer Stocks’ Sales Recover
We’ve long touted the strengths of consumer defensive stocks in a time of high inflation, given their ability to pass through price increases. For two years, firms like Unilever ULVR and Procter & Gamble PG have been raising prices at similar levels to inflation in order to meet their increasing cost bases and protect their margins.
As inflation has returned to more normalized levels, the necessity to push through price increases has lessened. That’s good news for both consumer firms and consumers. It has allowed management to shift focus to more effective marketing instead of shrinkflation and other clever ways to increase prices. We expect this level of investment in promotion to continue for the next few quarters.
These actions have worked, with the large consumer firms reporting steadily rising volumes over the last few quarters. Falling inflation and pay packets that are finally catching up, have naturally allowed consumers to purchase more of what they want.
Valuations in the consumer defensive sector have been creeping upwards, but there still exists some skepticism over whether we are through the worst of the macroeconomic headwinds, meaning that stock opportunities still exist. We still see plenty of upside in some of the household product names, as well as the global beverage firms.
Oil: There is No Alternative (Yet)
For much of 2024 the energy sector had been performing strongly, with gains inline with the broader market. This has changed over the last few months. First, OPEC has announced plans to increase output. In a finely balanced market like we have currently, this means a lower oil price, which has filtered its way down to European oil stocks. Add to this weak economic data out of China, which also means weaker demand for oil, and the short-term picture for the sector is not amazing.
While we’re all for taking advantage of short-term blips in stocks, we’re long-term investors. Our positive longer-term and slightly contrarian view is that peak oil demand has not yet been reached. Many commentators who are negative on oil draw comparisons to coal. Our rebuttal here is that oil is not so easily substituted. Electric vehicles, for example, threaten just one usage of oil, and with the EU and the US slapping tariffs on Chinese EVs, growth in this sector might not even materialize as quickly as people had hoped. In sectors like petrochemicals and plastic production, there is no close alternative to oil on the near-term horizon.
When it comes to energy stocks, we see long-term potential and believe investors should be looking at the currently attractive valuations with a view to taking advantage of this.
EU Technology Stocks Still Languishing
Tech stocks, and in particular those relating to AI, led the market fall in August, and indeed the subsequent fall in September. Some stocks, like Nvidia NVDA, have broadly recovered lost ground since then, but other high-profile names like Arm Holdings ARM and ASML ASML are still languishing, with the latter taking further legs down in recent weeks on the back of a disappointing near-term outlook.
Based on our bottom-up analysis, technology as a sector in Europe is still undervalued, albeit by just 5%, but within this there are some wide disparities. Stocks like SAP SAP are trading more than 50% above our fair value estimates, while others like ASML are now offering material upside. Last month, we actually looked at the 20 most overvalued stocks in Europe, and found just a single tech name: SAP.
Why is this important? Year to date, gains in the sector have mirrored the general European market, returning more than 20% to investors. But more than this, tech has been a good bellwether of general market confidence, partly due to the sector’s sensitivity to interest rate movements, and ultimately the belief that the macroeconomic situation in Europe is improving. For this reason, we believe investors should be keeping a close eye on tech stocks in the coming months, and should be taking advantage of opportunities like ASML.
