Bank of America expects the Russian invasion of Ukraine to accelerate and transform seven investment themes across Europe, including a substantial increase in defence spending and a sector-wide energy transition to renewables and independence.
The Russia-Ukraine conflict is set to have far-reaching effects that will reshape European geopolitics, societies and financial markets, according to Bank of America (BofA).
In a report titled European Thematics: A New Direction for Europe that was published on 22 March, the bank identified seven key structural investment themes that it expects to redefine Europe because of the conflict.
“The consequences will range from the development of new industries, the acceleration of existing ones, additional infrastructure and technologies,” it states, adding that the conflict could also come at a cost to some industries.
The thematic trends highlighted are increased defence spending; a greater emphasis on environmental, social and governance (ESG); a sector-wide energy transition to renewables and independence; reshoring for the security of supply; structural changes to achieve better cost competitiveness; and higher inflation and interest rates.
The report also singled out several stocks across 13 sectors that are exposed to each investing theme, of which have a collective market cap of $1.75trn.
Increased defence spending
BofA anticipates Europe to increase its defence spending budget to between €150bn and €200bn in 2022 and 2023, following Germany’s decision to double its defence budget on 14 March.
Estimated increase in Europe's defence spending budget in 2022, per Bank of America
The investment bank believes cybersecurity, space-based connectivity as well as research and high-end technologies, such as semiconductors, will be a priority for “European defence supremacy”.
Within the defence and technology sectors, BofA noted four stock picks, including aerospace manufacturers Thales [HO.PA] and SAAB [SAAB-B.ST], arms maker Rheinmetall [RHM.DE] and security technologies developer Hensoldt [HAG.F].
Energy transition to renewables and independence
Energy independence is the “number one strategic priority” for Europe, BofA said. However, moving the region’s reliance from Russian oil and gas is expected to require significant investment across three core areas: gas infrastructure, low carbon energy sources and carbon capture. In the push for energy independence, the bank’s stock picks are Shell [SHEL] and Equinor [EQNR].
While BofA is sceptical of Europe’s ability to achieve this in the short term, it expects the region’s long-term energy transition to be key to achieving independence. It sees growing investment in seven areas, including in renewables, nuclear energy, gas and electricity networks, energy efficiency, alternative energies such as biofuels, hydrogen and carbon capture, and electric vehicles (EVs).
There are several companies that it highlighted as its top picks, including Vestas Wind Systems [VWS.CO], Siemens Energy [ENR.DE], Aker Carbon Capture [ACC.OL], Mercedes Benz [DAI.DE], Air Liquide [AI.PA] and RWE [RWE.DE].
Reshoring and security of supply
According to BofA, for Europe to reduce its reliance on external supply chains, several policy and corporate initiatives are needed to accelerate reshoring. One of the three areas that the report suggests will be a focus is semiconductors. It forecasts production capacity to increase to 20% global market share by 2030.
Industrial automation and software companies are also expected to help shorten supply chains, with increased investment across artificial intelligence, cloud computing and 5G deployment. Another core part of the region’s plan for reshoring will be to secure supply partnerships.
Structural industrial challenges to remain competitive
Rising energy costs across Europe is also expected to make certain areas of its industrial sector, such as chemicals, oil and gas, automotive and some energy-intensive segments, uncompetitive, BofA explained in the report.
As a result, the bank believes that a greater focus on alternative energy production could help to offset this. The three stocks that it expects to face headwinds include BASF [BAS.DE], Yara [YARIY] and Outokumpu [OUT1V.HE].
Higher inflation and interest rates
After a long period of record-low interest rates, BofA believes that the next few years will be defined by higher inflation and higher interest rates. Under a scenario of a slowing economic environment with no recession, it believes that banks are set to grow, generate cash and redistribute it.
At present, it states, this isn't being priced in. Conversely, real estate — one of the big winners of the low-interest rate environment — will face a much tougher period. Finally, it sees significant downward pressure on low-income consumer purchasing power and, as such, is cautious on retail overall.
The rise of ESG
BofA also believes that the Russia-Ukraine conflict will lead investors to reprioritise ESG investing, with a particular emphasis on governance criteria. Another factor that is expected to change is companies that manufacture weapons. It foresees weapon manufacturers being not “no-no anymore”. While the bank did not single out stock picks for this theme, it did highlight the energy and defence sectors as being the two most primed to benefit.
The seven investment themes that BofA discussed in the report does not represent an exhaustive list of all the structural changes that Europe could go through. “Instead, we see it as a list of the most impactful and long-lasting themes that emerged from our discussions with our research department.”