John Bennett, Head of European Equities, looks at the shift from ‘growth’ to ‘value’ in global markets, and assesses what this means for Europe. He discusses his tactical moves prior to the shift gathering momentum, and what he sees as the key catalysts for improvements for European banks.
We are often asked by investors what we expect to be important in moving markets. This year, we believe earnings growth to be particularly important, with certain sectors, which have until now been complete strangers to earnings upgrades, starting to benefit from upwards revisions.
As part of this theme, we believe markets globally are moving from favouring ‘growth’ stocks and instead turning to ‘value’. This marks a meaningful reversal following the sustained period of growth markets since the financial crisis. For most of that period, you would not have wanted to own so-called ‘value’ stocks, so the second half of 2016 and beginning of 2017 marked a long overdue reversal in that trend.
For us, this shift in sentiment is based on a number of factors. We believe that central bankers are running out of road on what they can do with quantitative easing, and this will reshape markets. In our view, we had also reached the high water mark for valuations on bond proxies – “quality”, low-volatility stocks that have been consistently in demand, and oh-so-comfortable to be in. In the last three months of 2016 the backdrop changed and suddenly it became very uncomfortable to be in these stocks.
While it is early days, the signs are good that this change in leadership could be durable. Such a shift, should it continue, favours Europe, home to many ‘value’ stocks, and is positive for the kind of stocks and sectors that investors have found easy to avoid for much of the last decade.
Portfolio implications: gradual changes
In investment terms we have always tried to avoid lurching from one side of the boat to the other. We tend to make changes in a more gradual or incremental way. While not wishing to be labelled with any particular style, it was back in 2015 when we started using the phrase ‘tilt to value’ when talking to investors. Our first step was a tactical move into oil stocks in the third quarter of 2015.
Our tilt to value accelerated significantly in the second half of 2016. That acceleration was writ large by our move into European banks despite, like many other investors, finding the sector still very easy to dislike. History shows that investing in European banks would have been a spectacularly wrong call from 2008 until recently, but we feel a combination of vastly improved capital ratios and a turning point in interest rate expectations has made the industry once again investable.
European banks: from the ridiculous to the sublime?
No investment case is made up of just one ingredient and, when it comes to making an investment decision, you should not wait until all the ingredients are lined up in front of you. To use a racing analogy, if you wait for five green lights to come on before you go, then you’re already too late. We saw a number of new ingredients introduced last year that made banks more compelling. While these were possibly not enough for a long-term investment case, we felt that the industry had reached its lowest point. The number one ingredient for us was the change in bond yields. Interest rates had stopped falling. The long end of the bond yield curve had stabilised, yields had stopped falling and a substantial portion of the long end of the bond market was in negative yielding territory. This was extraordinary, an exceptional situation.
We were looking for catalysts for this extraordinary situation to revert to something more ordinary; in other words, we were looking for a more normalised yield curve. That was the number one ingredient we felt was needed to become remotely interested in European banks. We took the view going into the second half of 2016 that this was likely to happen, and it was then that we reinvested in the sector. So far, this view has proved well founded and, if momentum continues, European banks should benefit further through 2017.