PLACE FINANCIÈRE & MARCHÉS — Fonds

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“Rising rates, earnings growth: let’s go for value”


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The post financial crisis period has been marked by 9 consecutive years of rising European stock markets with an unusually long underperformance of value companies against their growth peers. However, market conditions are changing and investors would be wise to prepare for a trend reversal.

Equity investments are usually founded on two main styles whose merits are often confronted: while growth investors are targeting companies offering high current or forecasted earnings, value investors focus on companies presenting low prices relative to their fundamentals.

Many academic studies have demonstrated the long-term supremacy of value strategies compared to growth ones; they have also established that this outperformance has usually been achieved at a markedly lower volatility than growth approaches. In other words, value investors slept better while enjoying better performance than their growth counterparts!

And yet, for nearly 10 years, since the 2008 crisis, the value style is experiencing disappointing results as it is illustrated in the chart below.

The prolonged period of weak economic growth that followed the outbreak of the financial crisis carries a great responsibility in the disgrace of value strategies. Indeed, in a context of sluggish growth, investors embarked on an insatiable quest for yield and chased companies with predictable earnings growth at nearly any price. That increased valuations of some of these companies to record levels. A prominent illustration of this trend in the US is the huge stock market success of the so-called FAANG companies (Facebook, Amazon, Apple, Netflix, Google).

Low interest rates also played an important role: historically, European value stocks tend to underperform when bond yields are going down. The reason of this correlation is rather simple: because growth stocks have a greater proportion of their cash flows occurring in the distant future, they present similarities with long-duration assets which are more sensitive to changes in long-term rates. As a result, growth stocks have benefited much more than value stocks from rates falling to record lows.

Investors obsessed by the search for yield have completely removed […] two essential criteria: the valuations and the quality of fundamentals.

Léon KirchLéon Kirch, Partner and CIO (European Capital Partners)

In summary, for 10 years, investors obsessed by the search for yield have completely removed from their investment processes two essential criteria: the valuations and the quality of fundamentals.

But market environment has started to shift and the consequences on the equity market will sooner or later be perceptible triggering a potential and long-awaited comeback in favour of value strategies.

Indeed, economic growth has recovered and the ultra-accommodative monetary policies that were implemented by central banks to boost economic growth and fight against deflationary pressures have become less and less relevant. Central banks are now progressively stepping of these exceptional measures and interest rates have already begun to rise.

Valuations are the same to markets as the law of gravity to physics

So you will certainly ask: could this not be again a false dawn for value investors? We do not think so for the very simple reason that to us, valuations are the same to markets as the law of gravity to physics. Great companies are not necessarily great investments if the price paid by the investors is too high.

And now that the macroeconomic and interest rate environment is normalising while the valuations of growth companies have, for many, reached undue levels, nothing seems to stand in the way of a return to favour of the value style.

This said, it does not mean that one should buy every single stock exhibiting low valuation ratios (P/E, P/B). Indeed, value investing is much more than this!

Let’s make an analogy: you do not buy a house just for its price per square metre; but you will also visit it and make sure it fits all your criteria.

We believe that the European stock markets still offer great opportunities for savvy investors.

Léon KirchLéon Kirch, Partner and CIO (European Capital Partners)

The approach applied in value investing and by ECP is similar: before the purchase, the company’s fundamentals are scrutinised and we only invest if we think it is a quality company benefiting from strong undervalued earning power.

Our positive view on value investing would not be very useful without a favourable outlook for the European equity markets.

Despite 9 consecutive years of growth, we believe that the European stock markets still offer great opportunities for savvy investors.

What is overlooked is often badly priced.

Léon KirchLéon Kirch, Partner and CIO (European Capital Partners)

First, economic growth is firmly anchored: profits are rising, leading indicators point to a growing economy, and European exporters benefit from a relatively weak euro. Secondly, the valuations of European companies are not excessive either compared to their historical average or to other developed markets, notably the United States.

Our third argument is less objective and is based on a contrarian approach: European equities are largely neglected by investors (mainly Americans who, in times of uncertainty, tend to fall back on their domestic market). And as a value investor, my opinion is that what is overlooked is often badly priced. There are undeniably opportunities to seize for investors who apply a very selective investment strategy.

Thanks to a disciplined investment approach which puts valuations and fundamentals at the forefront of the analysis process, value investors have been able to generate over time superior returns at lower risks since Benjamin Graham, the father of value investing, has built the concepts at the beginning of the ’30s.