Stocks have been pushed around by political and macro factors more than usual this year but despite a busy political calendar in 2017, our strategy colleagues expect this to normalise. From a bottom up perspective we feel most compelled by Spain, by German residential, and by logistics.
How to play UK property stocks?
The outlook for London offices is challenged with rising supply and most likely sluggish demand, which we think will lead to rental declines and softer yields. UK retail property values are also at risk owing to stagflationary pressures and rising business rates. But then most stocks screen cheap on NAV, some even look good on earnings. Therefore, in absolute terms downside risks may be limited, but we see no clear catalyst to drive these stocks higher while the deterioration in fundamentals accelerates; in relative terms we see more value elsewhere in the sector. We highlight Segro as our most preferred UK name as it is exposed to the compelling logistics market.
Coping with bond yield anxiety.
Over the long term property stocks' performance relative to European equities tends to be positively correlated with
bond yields, even if this has been different in recent years. Recent underperformance is consistent with previous periods of sudden bond yield rises. But this tends to be short-lived, and a sustained rise in bond yields with higher inflation expectations usually leads to solid property stock performance. Our multi-cycle analysis suggests this could be the right time to revisit attractive equity stories in this sector. We appreciate that this time could indeed be
different, but then history suggests it rarely is.
Top picks.
Our key OWs are Deutsche Wohnen, LEG and Vonovia (we think German residential yields will fall further despite higher bond yields), Merlin (the cyclical rental recovery is imminent we think), Segro (logistics is one of the most
attractive asset classes in Europe) and Unibail-Rodamco (largely on valuation).
Potential surprises.
On the positive side, we think that if we are proven wrong on Spain it will be by not being sufficiently bullish. We also see potential for upside surprise in cities such as Frankfurt driven by financial services demand. On the negative side, we could envisage a material downturn in Swedish property.
Where could we be wrong ?
Our fundamental bottom-up approach skews our stock positioning towards eurozone stocks. But then we are alive to the fact that next year's political calendar contains several risk events that could potentially reduce the relative attractiveness of eurozone exposure. To some extent our recommendations offer some hedging as several of our OW rated stocks are German, and we would expect strong demand for real assets in Germany in case of heightened risk around the Eurozone.