Vincent Iméneuraët
European Equities Portfolio Manager
After getting the year off to a roaring start, the equity markets dampened investors’ enthusiasm in August, with the EuroStoxx with dividends reinvested down by 3.1% on the month.(1) The main reasons for the dip were Fitch’s downgrade of the US’s credit rating, which drove bond yields up, and Jerome Powell’s firm language at the Jackson Hole meeting of central banks. The steeper-than-expected decline in the PMI Composite in Europe, to 47.0(1) fed sentiment of a weakening in the continent’s economy. This explains its underperformance vs. a US market that was more resilient (S&P -1.6% in dollars with dividends reinvested)(1), much like the US economy. This correction was especially apparent in certain cyclical sectors, such as autos (-6.7%) and manufacturing (-6.9%)(1), which, however, did not derail the rotation into value(2), which began in mid-June.
Despite this rotation, valuations of European value stocks are still just as attractive, at 8.7x in P/E terms(3), slightly above the 10th percentile of their historical (20-year) valuations, vs. 12.3x for the MSCI (slightly below its median)(4).So the contrast is still as apparent with growth(5), at 20.1x P/E (higher than the 80th percentile), despite the underperformance by consumer goods and techs on the month (respectively, -5.8% and -4.8%)(6), owing to rather disappointing releases. However, at 22.7x for consumer goods and 20.6x for techs, they are still highly rated compared to energy (7.6x), banks (6.2x) and autos (5.3x)(7), which already seem to have priced in an economic slowdown, even though reporting season was rather solid for these sectors and even very good in the case of financials. Hence, 2023 earnings per share (EPS) forecasts were once again raised in autos and banks, bringing the year-to-date revisions to +20.1% and +23.7%(8).
In this environment that is challenging but favourable for value stocks, R-co Conviction Equity Value Euro held up well in outperforming its benchmark by +1.4% on the month.(8) Given the value bias the market has assumed, two thirds of this outperformance was due to allocation, particularly our overweighting of energy (+3.1% in August). The other third was due to stock-picking, driven by gains by Société Générale (+6.1%) and even more so by Ayden’s (-54.3%)(8) absence from the portfolio.
The tightening of monetary policies appears to be spilling over gradually into the real economy, particularly in Europe, where leading indicators continue to weaken. This slowdown was expected and is consistent with more stringent credit conditions and weaker demand reported by companies. We stuck to the relatively conservative bias we took on last March, as we believe the US economy could soon run out of gas – excess post-Covid savings were expected to run out by the end of August(9), and the resilience of US consumers could therefore take a hit, which would prolong the slowdown in global economic activity. With this in mind, we have kept our cash store between 6% and 7%, and the portfolio’s defensive/cash pillar at close to its all-time highs, at 34%.
In portfolio management, we made a few arbitrage trades within our cyclical exposures. Early in the month we reduced our holdings of stocks that had performed well on the year to date (Stellantis, Saint Gobain, Ryanair and Inditex) to add to our commodities exposure. We believe commodities are close to bottoming out, given their weak year-to-date showing (-4.8% as of end-July)(10), downward revisions to its 12-month forward EPS forecasts (-40% off their highs vs. -30% on average during recessionary periods)(11), and the Chinese government’s signals of support.
Inflation figures that remain stubbornly high from month to month back our baseline scenario of a shift in the inflation / monetary policies / interest rates paradigm. In the long term, with inflation that could stay structurally above central banks’ targets, due mainly to massive investment needed to finance the climate transition, value will maintain its relative attractiveness. Judging by value’s discount to growth, this shift in paradigm is far from having been priced in by the market. Meanwhile, in the short term, if the soft landing scenario does come to pass in the coming quarters, value’s natural cyclical bias is likely to provide it with some support.
