The divide between value and growth sectors in Europe and the US has never been larger.
Most value stock plays — including banking, energy, industrials and retail sectors — have been the hardest hit during the 2020 market crash, while defensive sectors such as healthcare and tech have remained more resilient.
That divergence is evident in the comparative performance of a number of BlackRock’s [BLK] ETFs: the iShares Euro Total Market Growth Large UCITS ETF [IDJG] and the iShares Edge MSCI Europe Value Factor UCITS ETF [IEVL], for instance.
Both funds track European stocks, but where the IDJG is down just 4.68% for the year to date (through 12 June), the IEVL is down 19.99% in the same period, revealing how value has been underperforming growth considerably.
Furthermore, the gap between the valuations of European stocks compared to their US counterparts has grown significantly. In mid-May European stocks were close to being valued at a record low compared to those in the US, according to Bloomberg. Meanwhile, the latter were being labelled as too pricey.
BlackRock’s European Value Fund, for instance, dropped 12.88% for the year to date to 12 June, compared to the 9.88% gains of the BlackRock US Growth Fund in the same period of time.
Amount BlackRock’s European Value Fund dropped YTD to 12 June
The former tracks large-cap European equities that are undervalued, including major holdings in the like of energy giant Sanofi [SAN], construction group Vinci [DG] and insurance company Zurich Insurance Group [ZURN].
Could a potential rotation into value stocks help European stock valuations gain on their US counterparts? Is this the tailwind BlackRock’s European Value Fund has been waiting for?
Market sell-off exacerbates value-growth divide
For the last decade, historical performance shows that portfolio managers picking undervalued stocks have lagged funds that hold growth stocks, research by Institutional Investor shows.
That divergence has only gotten larger recently, as the pandemic-induced downturn devastates companies such as banks, commodities and manufacturers, which are reliant on productive economies.
Considering that the European market has an extensive presence in these sectors, this has put it at a massive disadvantage, according to analysis by Bloomberg. Meanwhile, defensive companies and high growth earners rallied, pushing the book value of the Nasdaq to record highs and giving the US an edge.
The S&P 500 has also recovered the losses from the downturn in mid-March. The US benchmark rallied 44.4% from a low of $2,237.40 back up to the pre-sell off highs of $3,232.39 achieved on 8 June thanks to the high growth in tech giants and pharmaceuticals. The index has retreated somewhat since those highs, down 6.9% from the June peak.
Amount the S&P 500 rallied from March low to 8 June
The Stoxx Europe 600, meanwhile, is up just 26.4% since mid-March lows, further widening the divide between US and European stock valuations.
Alberto Tocchio, chief investment officer at Colombo Wealth, told Bloomberg that his firm is advising clients to stay clear of European value sectors, “mainly due to light investor positioning and fundamental valuations”.
“In order for Europe to take the lead regionally, we really need a rotation into more cyclical and value areas of the market,” Nathan Thooft, Manulife Investment Management’s head of global asset allocation, told Bloomberg in May. He added that he was “not convinced we have the necessary level of economic clarity for that to happen.”
Despite Thooft’s reservations, Evercore ISI strategist Dennis DeBusschere believes the long-awaited value rotation might be coming.
“Another round of fiscal support and a treatment/cure are critical for a persistent value rotation,” DeBusschere wrote, according to Bloomberg. “The next two months could be the sweet spot for that trade as a fiscal stimulus is likely before the end of July and the human ingenuity trade (vaccine/cure development) remains positive.”
“The next two months could be the sweet spot for that trade as a fiscal stimulus is likely before the end of July and the human ingenuity trade (vaccine/cure development) remains positive” - Evercore ISI strategist Dennis DeBusschere
If the economy improves in such a V-shape, as some predict, it could support conditions for a rotation to value equities in the medium-term. Furthermore, if this recovery were to happen earlier and faster in Europe than in the US, then European value stocks could benefit as investors flee comparatively expensive stocks such as the US tech giants.
Could financials lead the charge?
Indeed, the spread between P/E in historical growth and traditional value stocks has never been so extreme. Take the European banking sector for instance.
The Euro Stoxx 600 Banks sank to an all-time low in mid-March. With the banking sector’s price to book at its lowest on record, according to data by Bloomberg, Nadege Dufosse, head of asset allocation at Candriam Investors, believes it “could be the most attractive value sector to consider when normalisation begins”.
However, Mark Freeman, chief investment officer at Socorro Asset Management, thinks that the ongoing pandemic will likely determine the outcome for value stocks. “It ultimately comes back to investors’ confidence of the duration of the pandemic, and how long it takes for the economy to rebound quickly,” Freeman tells Bloomberg.
“On the days when the market feels like the duration is going to be short than what’s expected, then value and small will outperform. On the days when maybe it’s going to take longer than expected, then everybody reverts back to mega-cap growth.”
“On the days when the market feels like the duration is going to be short than what’s expected, then value and small will outperform. On the days when maybe it’s going to take longer than expected, then everybody reverts back to mega-cap growth” - Mark Freeman, chief investment officer at Socorro Asset Management
But for some, equity markets still remain too expensive. Seeking Alpha’s Alpha Generator believes “the risk/reward equation is skewed to the downside, adding that they have “implemented this view in [their] own portfolio by shifting largely to cash, gold, and long index put option positions.”
While it is still too early to tell whether a shift to value will occur, the pace at which the global economic recovery takes will likely be the determining factor in the medium-term. Until then, European stocks and the likes of the BlackRock European Value Fund will remain poised for a change.