The value rebound following "Pfizer Day" has come to a halt
While European markets have been setting record highs[1] for several weeks, they have been largely driven by growth stocks[2]. The underperformance of the value style since mid-May in relation to growth is the result of concerns linked to an economic recovery that is already well underway and the spread of the delta variant, which have brought rates back to their low points, penalising cyclical and financial stocks. Add to this the context of regulatory repression in China, the less dynamic “reflation trade”, and growth concerns that have superseded inflation fears, distancing the prospects of a less accommodative monetary policy. The style rotation has been violent, and “value” is now underperforming “growth” since the beginning of the year by 4.8%[3] as of 31 August.
Despite this unfavourable context for value, R-co Conviction Equity Value Euro has outperformed its benchmark[4] by 3.2% since the beginning of the year* and the Eurostoxx Value by 4.0%*.
This outperformance relative to the “value” style is largely explained (for 3/4) by stock selection.
Indeed, if the earnings seasons were exceptional in 2021 for value, this was particularly true for our main positions in cyclical sectors, namely Stellantis (4.7% of the fund**), ArcelorMittal (4.0% of the fund*), Saint-Gobain (3.8% of the fund**), and Cap Gemini (2.7% of the fund**) Buoyed by excellent operational performance and attractive valuations, these stocks have posted gains of 40% to 68% since the beginning of the year*.
While the marked overweight in the banking sector was also a source of outperformance, the contribution was particularly positive for some of our convictions within the sector: Société Générale (3.3% of the fund**) and Unicredit (3.1% of the fund**), which rose by 60% and 40% YTD* respectively.
It is therefore the fundamental approach, which is the DNA of R-co Conviction Equity Value Euro and at the heart of the management process, that has enabled the fund to stand out in the value universe, as shown in the graph (page 2).
Several elements should allow the “value” style to resume its march forward
1. Vaccines have made he health situation seem manageable. The health situation remains a concern for the markets, particularly because of the spread of the delta variant in countries where the vaccination rate is lower (Asia) and in those where the vaccination campaign started early (Israel, US). However, the vaccines have proven their effectiveness in severe forms, and mobility has been very little affected in recent months. Although boosters will be needed in the future, governments and populations are learning to live with the virus and lockdowns seem to be avoidable, suggesting that economies will continue to reopen.
2. Economic growth is expected to remain strong. Although growth has already peaked, it is expected to be robust in the second half of the year given: (i) the potential for further reopening mentioned above, (ii) the stimulus package unfolding in Europe (which will account for 5.25%[5] of GDP), (iii) the rebuilding of inventories after bottlenecks, and (iv) strong demand supported by accumulated savings.
3. Real rates are at their lowest as tapering approaches. Recent fears have pushed rates down. However, in a context where inflation remains high (Core CPI at 4.3% in August[6]) and employment is recovering, the Fed should start tapering by the end of the year. It is therefore difficult to imagine that this will not lead to a rebound in real rates which, as we know, would be favourable to “value”.
4. EPS support is still there after a record reporting season! Second quarter results have again surprised strongly to the upside and most companies have raised their forecasts, especially in the “value” segment. Indeed, 48% of “value” companies beat expectations by more than 5%, compared to only 18% of growth stocks[7]. Despite a less favourable comparable basis in the second half of the year, EPS growth is expected to remain very high for “value”[8], while its valuation discount to growth is at its historical low.
Fund positioning
R-co Conviction Equity Value Euro is positioned to benefit from the recovery of the “value” style.
The fund favours cyclical and financial sectors whose prospects for profit growth and low valuations still offer significant performance potential. As such, the fund is overweight the automotive, construction and energy sectors by around 4% and the banking sector by 10%.
However, we are staying away from growth sectors such as consumer goods and technology. Their valuation is rather high, which makes them sensitive to any disappointment, as shown by the recent underperformance of the luxury sector (P/E 21e of 33x) following the Chinese government's statements. This is why we believe it is appropriate to maintain our underweight position on these stocks in the current environment (low interest rates, less attractive EPS growth, regulatory concerns in China).
Over the last few months, due to stock selection, the fund has demonstrated its ability to resist in a particularly adverse environment: value has returned to a low point both in terms of relative performance (-4.8% YTD) and relative valuation (55% discount to growth compared to a 10-year historical average of 35%). Today, the continued reopening of economies, the growth of cyclical and financial stocks and the level of interest rates in a buoyant growth environment (particularly in Europe) are all factors that will favour the value style in the months to come.
* at 31/08/2021.
** average position between 31/12/2020 and 31/08/2021.
[1] The European Stoxx 600 (SXXP Index) exceeded its all-time high since the end of March, and exceeded it by +8.5% on 31/08/2021 (Source Bloomberg) and the EuroStoxx (SXXE Index) exceeded its all-time high since 01/04/2021, and exceeded the latter by +8.0% as at 31/08/2021 (Source Bloomberg).
[2] ASM International +42%, Alten 38%, ASML 33%, Dassault Aviation 33% and in general, the technology sector up 19.7% (increase between 15/05/2021)
[3] Source Bloomberg: Value SLVT Index, Croissance SLGT performance index from 31/12/2020 to 31/08/2021.
[4] SXXTIndex Eurostoxx dividend reinvested benchmark. Fund performance 23.2%. Index performance 20.0%. Source: Bloomberg 31/08/2021.
[5] Source: European Commission, National Assembly: https://www2.assemblee-nationale.fr/content/download/310171/3008002/version/1/fileNote+suivi+n%C2%B010+plan+relance+ue.pdf
[6] US CPI Urban Consumers YoY NSA - Consumer Price Index - Source: Bureau of Labor Statistics.
[7] Source: MSCI, Bloomberg, Morgan Staley Research - 08/2021.
[8] Source: Consensus Factset.
