It takes three to tango
Monday, 17 February 2025 12:08
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The announcement that the US administration was conducting peace negotiations with Russia on Ukraine came as a surprise. It was not so much the fact that Trump wants to stop the war in Ukraine – he was vocal about that during the electoral campaign – but rather about the process, i.e. the fact that he is negotiating alone with Putin over terms that would have significant implications for Europe as a whole.
In this report, we do not dig into the process and the terms of the deal. Many question marks remain and will ripple through the media in the coming days and weeks. Instead, the key questions from the standpoint of investors are twofold. First, is there a good chance that a peace agreement will be agreed in the coming months? And then, what are the market implications from a cross-asset and European equity market perspective?
- Regarding the first question, we believe the US President can indeed force Ukrainians to accept a deal, whether it be a good or a bad one. According to the Kiel Institute, the US has been the largest bilateral donor to Ukraine, with total commitments approaching EUR120bn as of end 2024, of which the bulk has been allocated to military purposes. Support from EU institutions + member states (EUR203bn) outpaces that from the US overall, but a significant part has not yet been disbursed (EUR90bn committed but not yet allocated as of end-2024). Hence, if Trump were to stop funding Ukraine, the war would probably come to an end and Putin would win on his own terms, which would probably be worse than any peace agreement. Hence, we believe there is a good chance that a peace agreement will be signed in the coming months.
- Regarding the market implications of a peace agreement, we believe that commodities would be the first shoe to drop. The prospect of Russia becoming respectable again may lead to the removal of sanctions and higher commodity supplies in the medium term. Renewed access to equipment would allow Russia to invest again in oil, gas, and industrial metals facilities to restore production. A decrease in commodity prices, inflation expectations and bond yields would support consumer sentiment and Trump’s approval ratings, while probably contributing to a US dollar reversal. Lower geopolitical risk would likely be a headwind for gold as well. Meanwhile, European manufacturing activity would experience an upturn. Lower bond yields would also prove more supportive for small caps versus large caps.
From a European equities perspective, consumers sectors with heavy exposure to European demand could see a boost from rising confidence and a falling savings rate: Travel & Leisure, Automotive, Retail, and even possibly branded Food & Beverages. We are already OW all of these sectors except Automotive, which we upgraded to Neutral three weeks ago (tariff uncertainty and poor fundamentals have limited our appetite).
A cyclical recovery in Europe would also trigger a rebound for the most cyclical part of the industrial goods and services sectors. We show in this report that only the “structural secular growth” segments within industrials have performed very well over the past three years. With attractive valuations and a favourable risk-reward balance, the segments Industrial Engineering (Atlas Copco, Sandvik, Kone, etc.), Support Services (Randstad, etc.), and Transport (Volvo, DHL, DSV, etc.) could rally, leading us to upgrade the overall Industrial Goods and Services sector to Neutral (from UW). The demanding valuations of the “growth” parts of the sector limit the upside in our view, although they remain well supported by fundamentals (AI, electrification, defence). It goes without saying that the stocks most exposed to European Defence spending continue to attract investor interest. Signs that the EU Commission is warming up to the idea of making the fiscal framework more flexible in order to allow for an increase in defence spending is a material concrete development for the bullish thesis. One risk to monitor will be more common procurement. But we are not there yet.
What to sell? We reiterate our UW stance on the European Oil & Gas sector and downgrade the Insurance sector from Neutral to UW. In the case of energy, oil markets remain over supplied and any drop in the geopolitical risk premium could weigh on prices. The Ukraine discussions and the likely OPEC decision to lift oil production on 1 April could lead to pressure on the oil price. Within the Defensive sectors, Insurance has performed very well thanks to strong shareholder returns and pricing power (reinsurance). That said, its relative valuation is almost at a peak, and we see better value propositions in other Defensive sectors: Healthcare, Food & Beverages, and Telecoms.
Finally, we put together a basket of European stocks that would benefit from a peace agreement. The process for building this Ukraine basket was twofold. First, we surveyed our equity analysts regarding the stocks under their coverage that would benefit from it. Based on this initial qualitative screening, we ran regressions on individual stock returns against Ukraine’s international bond, which captures the newsflow indicating the likelihood of a peace agreement. We ended up with a list of 21 stocks with heavy representation of sectors such as industrials, construction and materials, and chemicals.
Week ahead: German elections on 23 February. FOMC meeting minutes and preliminary PMIs in major countries.
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