European equities: will value prove victorious in 2021?

For nearly a decade, the value versus growth debate has culminated in majority wins for growth stocks. 2020 was no different, marking the fourth year in a row that growth stocks have outshone value, with the MSCI EMU Growth Net Return Index outperforming the MSCI EMU Value Net Return Index by 14.37% .¹ But what was the cause of this in 2020?

Fiscal policy propels growth

The COVID‑19 coronavirus, which was declared a global pandemic on 11 March 2020, has had remarkable effects on people’s day to day lives. With most countries adopting widespread lockdown measures to stop the spread of the disease, many individuals and businesses have been forced to stop trading, and the global economy has suffered as a result. Many central banks across the world attempted to remedy this by injecting massive amounts of funding into the system; the European Central Bank employed a €1.85 trillion pandemic emergency purchase programme (PEPP), buying vast amounts of private and public sector securities to funnel money into the economy and ease the burden of the lockdown restrictions. In short, central banks gave away ‘free money’ and Robinhood (retail) investors came out to play – bidding up stocks and sectors that were viewed by investors as offering growth. Given that growth sectors/companies are generally less reliant on gross domestic product (GDP) growth to stimulate demand for their products, and hence their earnings are less correlated with economic activity, these stocks found favour over value.

Can value emerge victorious?

Against this background, should value investors simply throw in the towel, admit that valuation measures no longer work and retire gracefully? In my opinion, the answer to this is a resounding no! Why? It is simple. COVID‑19 is transitory, and as such, its negative effects on GDP will abate. As economies and investors move into recovery mode we believe that value is likely to rise to the fore.

‘Free money’ offered by central banks is a tad more problematic but if the thinking is that inflation is likely to rise – gold and crypto currency investors certainly believe this – then, at the very least on a relative basis, value should benefit.

Why might inflation rise?

This is a difficult question to answer and probably worthy of an article in itself. Briefly, Modern Monetary Theory, if adopted, would probably stoke the fires of inflation, as would increasing trade barriers, companies moving supply closer to home and wage inflation. In addition, the chance of a strong recovery in demand post COVID‑19 encountering an anaemic supply, due to companies closing down during the pandemic, could also fan the flames of inflation. These factors, in isolation or in combination, could lead to a rise in inflation.

All of the above assumes that the current valuation of so-called growth stocks is appropriate and not a sign of a bubble reminiscent of 1999‑2000, which would be problematic for investors overly exposed to this area. In this respect, the jury is still out.

Cautious optimism

Compared to 2020, we expect the outlook for this year to be more positive. As vaccines are rolled out this should enable economies and business confidence to recover, while interest rates seem likely to remain low – helping to reduce the risk of debt. Given the existing and rising levels of corporate and government debt, this is no bad thing.

However, as the costs of the pandemic start to crystallise, risks will heighten. If companies feel the need to strengthen their finances, returns for investors may be reduced. Should companies decide to hold higher levels of stock, this could also lower returns. Individuals may decide they need higher cash buffers and increase savings by reducing spending, which would have the impact of lowering aggregate demand. Thus, while it seems very likely to us that 2021 will come to be remembered more fondly than 2020, risks remain as ever.

¹ Source: Bloomberg. Index returns in EUR terms from 31 December 2019 to 31 December 2020. Past performance is not a guide to future performance.