The fund manger is not convinced by the strong performance of the US market. Europe is a surer prospect for both value and growth stocks.
As a fund manager I’ve never been too fond of the idea of “talking up the asset class”, which in my case would have meant extolling the virtues of European equities. I’ve always felt that doing so risks becoming an apologist for a region or an asset class, thereby risking at least some element of self-serving disingenuousness.
But my temporary departure from this way of thinking is due to what we perceive as the prospect of an inflection point on the horizon.
If we limit ourselves to just looking at ‘the index’ as our measure, the impression we will get is that European equities – from an asset allocator’s perspective – have not done well, to say the least. The graph shows the MSCI Europe index compared to the US S&P 500 index, rebased to 100 in January 1980. Around 2011 you can see the decoupling between the indices, and it’s no coincidence that this decoupling coincided with the great growth stock boom.
Out of favour
European equities have fallen out of favour, and a contrarian (or mean reversionist, or value investor) might at this juncture be tempted to take the other side and argue that European equities offer a great investment opportunity. As a mean reversionist, my fundamental belief is that the share price of a company, its profitability, its growth rate, will eventually revert back to a mean and that out-of-favour companies can present opportunities to investors over time. Such an argument is surely understandable when we remind ourselves that fashion plays a regular and often cruel role. Right now, it is fashionable to declare that the future belongs to “the disrupters” and the past to “the disrupted”.
Away from predictions, one clear reason for Europe’s underperformance of the US is corporate earnings. Based upon corporate earnings growth, Europe has deserved to underperform America – of that there is no doubt. However, it is worth questioning whether the European die really is cast.
Dear old Europe is home to a paltry number (and value) of technology companies, while America demonstrates its prowess in all things “tech”. Tech is 30% of US market capitalisation, but only 6% of Europe. However, those of us with memories of previous boom sectors are reminded that 30% of a mainstream index has tended to mark the peak. We are particularly reminded of financials in the US and Europe back in the mid-2000s.
No gorging in Europe
Further, unlike the US, Europe has never been infused with – nor enthused by – the equity culture, and thus share buybacks as a means of earnings-per-share or share-price support have never been that popular. In contrast, emboldened by executive compensation schemes and plentiful supplies of low-cost debt, corporate America has gorged itself at the buyback feast. Add to that the bottom-line boost from president Trump’s tax reforms and maybe, just maybe, America’s stock market boom isn’t all down to vastly superior operating models.
In other words, sufficient evidence exists to suggest that the age-old inputs – and potential nemeses for investors – of investor crowding (fashion) and artificially boosted earnings (cheap money, leverage, buybacks, tax breaks) are at work. As sure as night follows day, those factors will not always be in investors’ favour. For example, one ingredient that would turn things in the investment world upside down, and catalyse a resurgence of value stocks, would be the return of inflation.
What we are really saying is that one doesn’t need to be a diehard mean reversionist to question the zeitgeist. A combination of investor positioning, the human tendency to extrapolate from share prices, growth rates or market share gains, a late-stage bull market in US equities and the US economy, not to mention valuation (it never matters until it does) all suggest that now is not the time to give up on Europe – nor indeed her equities. Now is not the time to abandon a selection of so-called “value” stocks in favour of an all-out “growth” (or momentum) portfolio. Happily, Europe offers an ample selection of both.
John Bennett is co-manager of Henderson European Focus Trust.