We have, for a long time, operated in an environment where investors favoured quality European stocks ‘at any cost’ over the alternatives. Growth has outshone value since 2007, with persistently low interest rates driving down the income from other assets, such as cash and bonds. This increased the appeal of stocks that investors believed could deliver a solid, reliable return, with stocks like the FANGs (Facebook, Amazon, Netflix and Google) foremost among them. The sustained and enduring nature of this growth bias has seen the elastic relationship between prices for growth and value stretched very thin.
The second half of 2016, however, saw a notable change in that mood music, with many quality growth stocks that we viewed as significantly overpriced at the start of last year de-rating, while more cyclical areas of the market, such as energy and financials, rallied strongly. The reasons for this are multiple, but broadly hinge on three factors: the rise in populism, which has put pressure on incumbent politicians to relax austerity; the expectations for long-term fiscal stimulus; and structural weakness in bond markets that has been caused by excessive ownership, coupled with the potential for rising interest rates (and the return of inflation).
Where can value currently be found?
Many expected the rebalancing between growth and value to continue into 2017, but European growth has been the surprise outperformer thus far (as at 22 March 2017). The question now is whether the revival in value was a short, sharp but temporary rally, or early signs of a longer-term rebalancing. There is no guarantee that reflationary pressures will continue and it is notable that the inflationary input from higher oil prices is not yet matched by higher wages, a long-term factor in driving inflationary trends. Nonetheless, European value undoubtedly remains one of the more interesting and contrarian investment opportunities of 2017.
Intuitively, value's long-term outperformance makes sense. Buying undervalued stocks is likely to result in gains over time, provided you avoid problem stocks, i.e. those companies that are stagnant or have deteriorating fundamentals. Within the Euroland, those countries that have adopted the euro as their principal currency, we are optimistic about the prospects for sectors such as industrials and materials, out of consumer-staples and telecoms, with a focus on the core markets of France and Germany. On a pan-European basis, outside industrials, we see a broader range of opportunities in IT, with some prospects in utilities and discretionary consumer spending areas.
A year of political theatre
European markets have taken America’s lead thus far in 2017, ignoring the potential for any problems caused by the electoral cycle. The results season has been broadly positive and stock market volatility is at lows. The political calendar remains heavy in 2017, with investors looking to the French presidential vote as the next potential flash point, following the recent Dutch election. While it seems unlikely that Marine Le Pen – head of the far-right, anti-immigration Front National Party – will take the presidency, you only need look at the collapse in popularity of recent hot-favourite François Fillon to understand that things can change quickly.
But stock market volatility is not something to be afraid of, offering an opportunity to identify quality companies trading at an attractive price, with a view to participating in a share price recovery over the longer term. From a rational perspective, value investing requires a longer-term horizon and it is important that investors avoid judging companies on unpredictable short-term market trends or sentiment. By focusing on the in-depth analysis of stock and market data, we believe it is possible to identify those companies with overlooked or undervalued potential throughout the market cycle.