Risky times call for a low risk stock

Looking ahead to 2017, it feels as though there are a number of major risks facing investors. In fact, it is difficult to think of a more uncertain time since the credit crunch. The ‘no’ vote in the Italian referendum is but the latest challenge facing investors. Depending on who succeeds the now former Prime Minister, there is at least an outside chance that Italy will leave the Euro. Alongside the pressure of Brexit on the EU and the upcoming French election, this could leave investors in an increasingly risk off mood.

In such a volatile period, lower risk stocks could be the remedy. SSE (LON:SSE) is among the index’s most resilient and defensive shares. Its low beta, high yield and dependable business model means that it could win favour among investors in 2017. That’s even before the prospect of an unpredictable US President is even considered.

The end of the Euro?

While we’re perhaps not at the stage when the word ‘disaster’ can be used to accurately describe the performance of the Eurozone economy, it has been a significant disappointment. It would be of no surprise if Italy left the single currency zone. After all, its economy is the same size as it was at the start of the century and its outlook is downbeat. Clearly, there is some way to go before it even comes close to leaving the Eurozone. However, the referendum result could be the beginning of the end for Italy’s membership of the currency union.


Further challenges for the single currency zone include the French election. It seems likely that a centre right government will win 2017’s election and they may be more willing to consider pulling out of the Euro than the current administration. If France or Italy were to leave then it would seem unthinkable that the Euro could continue. They are the second and third largest economies in the single currency zone respectively and it could be argued that they are vital to its long term sustainability.

The Trump and Brexit factors

In addition to the problems facing the Eurozone, 2017 is also set to be a volatile and uncertain year because of Brexit and the new US President. Brexit will add to the pressure facing the Eurozone. One way in which this may manifest itself is in a tougher negotiating stance from the EU. Although the UK is not a Eurozone member, the deal it strikes with the trading bloc could influence other nations to consider leaving not just the Euro, but the EU. For instance, a good deal for the UK may cause French voters to push for a Frexit in future, which would destabilise the region even further.

…a good deal for the UK may cause French voters to push for a Frexit in future, which would destabilise the region even further.

The Trump Presidency adds another dimension to 2017’s risky outlook. He is no fan of the EU, but his attention is likely to be focused on reducing taxes and increasing spending rather than on European woes. Those policies could cause high inflation, while his actions on the international stage may increase market volatility out of their sheer unpredictability. A more aggressive defence spending programme could also heighten tension in a military capacity and cause even greater market volatility in 2017.

A potential remedy

Against a backdrop of high uncertainty, investors may look to lower risk stocks such as SSE. It has a beta of 0.4, which means that its shares should move by less than half as much as the wider index. If 2017 proves to be a volatile year, this could provide at least a degree of stability instead of the wild swings in share price which more cyclical stocks may endure.


Added to its low beta status is a business model which is exceptionally defensive. Whatever happens with Brexit, the Euro and Trump as President, the supply of electricity will continue and demand is unlikely to change all that much. Furthermore, SSE has a relatively well-diversified business model. It is involved in the production of electricity via its renewable and thermal assets, while it distributes electricity in northern Scotland. The company is also an electricity supplier throughout the UK, which means that its overall risk profile may be lower than for some of its utility sector peers.

Outlook

SSE’s valuation is relatively appealing. It has a P/E ratio of 12.7, which is lower than for a number of other utility companies. Water services companies Pennon (LSE:PNN) and Severn Trent (LON:SVT) have P/Es of 18.9 and 20 respectively, while National Grid’s (LON:NG.) P/E of 14 is also higher than that of its sector peer.

If it were to trade on a P/E of 20 then it would still yield 3.8%, which is higher than the wider index.

Although it may seem improbable that SSE’s P/E will move much higher given that its EPS is forecast to rise by 4% next year, demand for lower risk assets could see its shares rise significantly. If it were to trade on a P/E of 20 then it would still yield 3.8%, which is higher than the wider index. Although this would be 40% above its all-time high, if demand for defensive, high-yield and relatively low-risk stocks increases then it could quickly become a realistic price target.

Future prospects

As the end of 2016 draws to a close, the prospects for a prosperous and smooth 2017 seem slim. The Eurozone is once again in crisis, with there being a realistic chance that Italy could leave the single currency area. There is also an outside chance that France will do likewise. Add to this the likelihood of a stalemate on Brexit negotiations alongside an unpredictable US President and it is clear to see why volatility will rise next year.


In such a scenario, owning a defensive stock such as SSE could be a prudent step to take. It has much lower volatility than the index and has a robust business model. Further, its valuation is reasonable on a relative basis given its risks, while a higher price would still see its yield remain above that of the index. Therefore, SSE could be a strong performer over the next year.