Irish Equities - No stock is an island

As we know only too well from our experiences with COVID-19, a year can feel like a long time. That was certainly the case with equity and indeed bond markets in 2022. Despite year-end rally in equities, markets still fell strongly overall in 2022, and Irish equities were no exception. However, with the perspective of over twenty years market experience, the rule book hasn’t changed and I have no doubt that in the long term, strong management teams and equity markets will flourish.

Of course, like COVID-19, market falls were not fair and equitable to all - some sectors within the market bucked the trend, with Irish financials having a standout year.

‘Rate rises are like rocket fuel’

Back in my younger, greener days in the market, one of the more memorable quotes from a senior fund manager sticks in my mind. On wanting to invest in Japanese banks at the time, he pulled up a chart which correlated interest rate expectations (implied from bond yields) and banks’ share price performance. He urged, “There’s only one thing you need to know about banks - interest rate rises are like rocket fuel”. Many years later, whilst acknowledging the issue is significantly more complex, I have to admit that in 2022,, for several reasons, the share prices of the Irish banks have taken off ‘like rocket fuel’.

This was accompanied by earnings upgrades from all three banks (AIB, BOI & PTSB) as interest rate rises fed through to profitability. Nonetheless, price performance cannot be simplistically attributed just to the changes in interest rate expectations, albeit the pace of rises did take the market by surprise. A multitude of other factors were specific to Irish banks including the exit of two major competitors from the market (KBC & Ulster Bank), the resumption of dividends, and changes to both lending (‘macro prudential’) and staff compensation cap rules to name a few.

No stock is an island

Even in a tough year for markets, there can be pockets of share price strength. Equally, staring into the barrel of what appears to be an inevitable recession across multiple regions this year, there will be pockets of opportunity. Some of this is simply down to geography– it’s fair to say that those Irish companies with significant UK exposure are considerably more cautious in their outlook than those that have US exposure, where the economic outlook is considerably better. Cyclicality also plays a part – some sectors are simply more exposed to cyclical spending than others. However, there are some sectors usually considered cyclical that are not yet seeing evidence of the much-awaited consumer slowdown.

Consumers prioritising experiences over products

One example is the travel/tourism industry, where months of lock-downs had given consumers a new perspective when it comes to experiential spending. Evidence from European airlines points to strong yields in recent months and decent levels of bookings into this year. Thus far, it seems European consumers are still prioritising travel over other spending. And whilst it’s entirely possible that price sensitivity could increase over time, this may arguably benefit some industry players more than others. Looking across to the hotel industry, demand so far has also remained robust in Ireland and larger UK cities. In Ireland, this is underpinned by the reported minimum of 15% of hotel capacity being given over to refugees from Ukraine and elsewhere – a situation unlikely to change imminently. An added layer of complexity for the travel industry overall is that corporate and other travellers are increasingly focusing not just on times and prices when making bookings, but also how their travel and accommodation needs are feeding into their overall carbon footprint.

There’s no place like home

I dedicated considerable column space to the Irish love affair with the property market in our last edition of MarketWatch. Hence, readers will be familiar with my argument that unlike the UK, where house prices are under pressure, the demographic and economic situation in Ireland is somewhat different. To begin with, whilst there are warnings about the possibility of a year-long recession in the UK, Irish Gross Domestic Product (GDP) is still set to expand in 2023, bolstered admittedly by foreign direct investment.

Furthermore, not having had Brexit to contend with, Ireland remains a country with inward migration. With an existing shortage of housing and years of chronic under supply, it seems we will see prolonged housing demand for some time – something recognised by the government. In addition, we have recently seen changes to the macro-prudential lending rules in Ireland, increasing the loan-to income multiple for buyers from 3.5x income to 4x from January 2023. When these rules are combined with the Help to Buy and Shared Equity Schemes, it could arguably put further inflationary pressure on house prices.

Earnings growth – beware of averages! Having established that even in a tough overall market and  macro-economic environment there can be pockets of growth, I’m wary of looking at averages – particularly for a very concentrated market like the ISEQ. However, it should be noted that whilst global valuations at the time of writing are back above long run averages, in Ireland valuations are still below long run averages.

Looking towards earnings, ISEQ earnings are set to grow 34.5% in FY23, (down from 42% in FY22). However, these earnings per share (EPS) growth figures are heavily upwardly skewed by financials and some larger names. There are expectations amongst several Irish listed companies for a fall in earnings, particularly for those with strong UK exposure. Furthermore, with analysts often being behind the curve, it seems reasonable to expect that there may be further downgrades to earnings for some names. Nonetheless, even factoring in some earnings cuts, many names in Ireland still represent good long-term value. Finally, even for companies where earnings are not set to grow, the oft-mentioned strength of Irish balance sheets comes to the fore, with many stocks choosing to buy back shares. Also, numerous stocks outside of the traditional realm have become yield plays, with yields of >3% not uncommon. Hence, in an environment where yields from savings are still low, risk-averse investors with a long-term view may decide that there are still plenty of opportunities for investment in Ireland in coming years.