Anthony Bailly
Head of European Equity
The European indices first-half rally spilled over into July, with the EuroStoxx, dividends reinvested gaining +2.1% on the month(1). This performance came in spite of divergent macroeconomic data in Europe and was driven by receding inflation, which raised expectations of a sooner end to the rate-tightening cycle and hopes for a soft landing. This led to catching-up in sectors that had been previously overlooked by investors (real estate:+10.1%; commodities: +6.1%; and banks: +6.1%), and the start of a trend reversal, including the shift towards Value(2) and away from Growth(3) that had begun the previous month(4).
Value stocks in Europe nonetheless remain close to their all-time lows, at 9.0x P/E(5), vs. 12.7x for the MSCI Europe(6), which is close to its historical low. Despite the style rotation begun in mid-July, there is still a marked contrast with the Growth style, which, at 21.4x, continues to approach its highs(6). Autos (6.1x), banks (6.6x) and energy (7.5x) are still trading at P/Es multiples below the tenth valuation percentile for over 30 years, which suggests that the ongoing slowdown in business activity is at least partly priced in within these sectors. We can’t say the same for consumer goods (P/E of 23.4x) or techs (P/E of 21.1x)(7) which, at multiples far above their historical averages, look far more vulnerable to an economic slowdown.
This is all the more striking as second-quarter reporting season maintained momentum in earnings per share (EPS) that is still favourable to certain Value sectors. During the month, 2023 EPS forecasts of autos and banks were revised upward, respectively, by +6.8% and +2.4%, with these two sectors having the strongest upgrades on the year to date (+17.6% for autos and +19.2% for banks)(8).
In this pro-Value environment, R-co Conviction Equity Value Euro gained 2.4% in July, thus outperforming its benchmark by 0.3%(8). Most of the outperformance was driven by allocation, as the fund rode both its overweighting of banks, energy and real estate, and its underweighting of techs and consumer goods.
We nonetheless feel that it is still too early to add to our portfolio’s cyclicality, as the impact of the tightening in monetary policy is just now beginning to show up, with demand for loans contracting at a record pace among corporates, and PMI leading indicators now also worsening in the services sector. In response to this expected slowdown, which is consistent with demand reported by companies during last reporting season, we have stuck with the relatively cautious bias that we have held since last March. Our portfolio cash was unchanged, at between 6% and 7% on the month, and its defensive/cash pillar remained close to its all-time highs, at 34%(9).
The portfolio breakdown was unchanged on the whole, although we did raise our bank exposure slightly through Bankinter. Regulatory fears continue to fade in the sector and the Spanish bank offers one of the best EPS growth forecasts. Meanwhile, it has underperformed its peers on the year to date; it continues to win market share on the Iberian peninsula; and its valuation premium has shrunk vs. its domestic competitors.
We are still convinced of Value’s potential in both the short and long term. In the short term, further hawkish monetary policies obviously continue to work in its favour. Moreover, as explained previously, some Value sectors already appear to have priced in a slowdown in economic activity. And, lastly, Value’s naturally cyclical bias is expected to help it out if the soft landing scenario is borne out. In the long term, with inflation that could hold structurally above the central banks’ objectives, Value will retain this relative attractiveness. Whether short or long term, this is all the truer as Value’s discount vs. Growth has risen constantly, even as we have entered into a new paradigm over the past two years, either over inflation, monetary policies or interest rates.
