15 MAI

2020

Covid-19 , Actions , Geoffroy Goenen , Thèmes

Growth vs Value Style in European Equities: Whiplash!

Since the Global Financial Crisis, Growth equities have significantly outperformed Value equities in Europe. The Value style has suffered from low and falling interest rates. But it was not a straight line! A history of the relative performance of the two styles since before the dotcom bubble offers a remarkable insight. We do not expect the next style rotation to offer the type of drama seen in 2000. Yet Chart 1 also reminds that value stocks do tend to lead in recoveries, such as the more modest value rotation following the 2008 GFC.

Our European Equity investment  style  focuses on Quality stocks, ESG, business models, and financial terms. Because of this focus on Quality, our portfolios tend to structurally overweight the Growth style. The dramatic recent outperformance in Growth style, especially during the early days of the ‘Covid markets’, creates a risk of a style rotation towards Value later this year, or at least a moderation in the wild ride of Growth.

At Candriam, our European Equity management processes incorporate a 20-year internal style model to detect, monitor, and manage style biases. Our valuation discipline, our internal model, and simple style performance indices from MSCI© as shown in Figure 1 are aligned. Our valuation discipline shows that on an individual basis, many of our Growth holdings have too much valuation downside. Our dynamic style management allows us the confidence to weather style rotations. Our continuous bottom-up fundamental and valuation analysis highlights Quality opportunities in the Value sector when faced with potential style rotation.

Chart 1: European Equities – MSCI© Growth vs Value style relative performance

Source: Candriam. Bloomberg. Value = MSCI© Europe Value Net Return EUR; Growth = MSCI© Europe Growth Net Return EUR.

Past performances of a given financial instrument or index are not reliable indicators of future performances

Chart 1 reminds us  that  growth  investors  can be whipsawed over the short term, especially in recoveries. Value has never been this cheap relative to Growth in Europe on our 20-year proprietary models. The relative performance of the MSCI Value and MSCI Growth indices offer a similar picture. Growth stocks have clearly been the fun place to be since early 2010s in Europe.

A bit of context

Given the significant demand shock which began in the first quarter of 2020, the more economically- sensitive sectors such as energy and materials have been hard-hit, especially those with the most earnings uncertainty. Oil equities faced large headwinds beyond the weak demand, given production quota disputes. The combined effect has been dramatic.

When analysing the graph, it is useful to consider what constitutes ‘Growth’ or ‘Value’.

  • Growth stocks, typically defined as higher earnings growth, usually sell at higher valuations. The MSCI© Europe Growth Index, designed to represent 50% of  the  market cap of MSCI© Europe, is defined by factor analysis of long-term and short-term forward EPS growth, current growth, and long-term historical EPS and Sales growth
  • Value stocks, typically defined as having a lower price in relation to earnings or assets, are defined for the MSCI© Europe Value Index using a factor model of Book Value to Price, forward P/E, and Dividend Yield.

‘Growth’ and ‘Value’ are not black and white. Style determinations can become murky when investors have sharply divergent projections for a company’s future, or when companies change over time.

Some investors will  include higher earnings variability  in  their  definition  of  Value,  because of the higher earnings variability which may be seen in cyclical Value stocks. And ‘Growth’ versus ‘Value’ might change during the life of a company. One example might be Microsoft; in late 2011, expectations of lower growth caused its shares to trade at a P/E ratio less than half that of Google. Might MSFT have been a Value stock to some, and a Growth stock for others? To address these issues, MSCI allocates 50% of market cap to each category, but companies may have proportional weightings. A stock under this definition might have 40% of its market cap in the Growth index and 60% in the Value index.

Most academic discussions of style focus on global indices. Market-cap based global indices overweight US equities relative to the size of the American economy, both because of the larger proportion of the economy which is publicly traded, and because of the often-higher P/Es.

To analyse European Equity styles, we need to set aside the global style thinking and strip out the US bias. One distortion to the global index is that the FANGS, a huge global weighting, are US equities. As of 1 May 2020, Information Technology constituted 7% of the a of the MSCI© Europe Index, but a huge 26% of the US S&P© 500 Index. Importantly to style analysis, growth is not all technology!

So what are the proportions of the Value industries in Europe? Healthcare leads the way at 17% (18% in the US), followed by Financials at 15% (10%). Industrials are 13% of the European index (versus 8% in US), and energy contributed 5% (3%).

All is not lost

Chart 1 shows the problem – when the markets decide they can see the recovery, investors are likely be whipsawed by a style rotation to Value. And Growth has had a good run. Similarly, while we expect a Value recovery, it too will be likely to end abruptly and without warning, punishing those who chose to overweight Value. This is where our internal style monitoring, and our individual stock valuation models come in to the process.

It is our conviction that Quality Growth stocks will outperform in the long term. There are two words there – let us focus on the word ‘Quality’. The Covid sell-off has been highly indiscriminate so far, with ‘good Value’ names being sold off alongside ‘bad Value’. The COVID-19 shock also created a rush to the exits in many Quality stocks. Many investors

The long and the short of it

We remain agile. We expect Value stocks could outperform Growth stocks in the near term, if we see stability in European and US bond yields, particularly as market positioning remains extremely underweight in value stocks. Accommodative monetary policies, hopefully moderating global trade relations, eventual stabilisation in macroeconomic data and a potential economic recovery once the Covid-19 storm is behind us, should combine with the market technicals to boost Value stocks.

We maintain our conviction that Quality stocks should outperform over the long term. And we maintain our investment style. We will re-emphasize the “Growth” in our Quality Growth bias in a more favourable market environment, capitalising on more attractive valuations. We will continue to be vigilant in our continuous examination of business fundamentals, changes to business models which may be necessitated by our new world, and changes in valuations. Our goal is to generate a return for our clients in a risk-aware and systematic way.

The track record of our European Equity strategies demonstrates our expertise in positioning our portfolios across economic cycles to adapt to market conditions, while maintaining the integrity of our investment processes. Conviction, selectivity, and agility will remain our motto.

Geoffroy Goenen

Head of Fundamental European Equity