Why now ?
We believe that we are currently at an important crossroad where the odds of an imminent return in favor of our investment style have dramatically increased.
At European Capital Partners (Luxembourg) SA, we will over the coming three months share our vision explaining why we believe value returns and what the current market environment has to offer a long-term minded investor. If you want to know more, visit our page frequently and scroll down to discover new updates.
3 reasons to invest now
Value is excessively cheap, but for how long?
Growth outperformance cannot go infinitely
“You can turn any bad investment into a bad deal by paying too much” – Warren Buffet
The economic cyclicality
Global growth currently hovers around 2.5% with confidence indicators still pointing to modest growth. Manufacturers suffers due to extreme negative business expectations and as a result orders are contracting. The confidence level in the service sector was held up well but is coming down on a global level, the trade tensions and uncertainty are lingering up and creates volatility. Furthermore, the risk of a no deal Brexit has increased, and the German government is moving away from its “Black o” mantra, which means they could increase expenditures in order to push economies. That would be a change in mindset for Germany. The fact that it already appears in discussions show there is a certain willingness to move.
On the monetary policy side, central banks are still in a very dovish mode and the Fed is following the trend and the ECB is opening doors to more quantitative easing and further rate cuts. The yield curves went from flat to inverted and ending up in negative territory, which results in negative yields for government bonds with corporates following the trend. However, the interest rates are already so low and we do not believe there’s much room to go lower.
We are coming out of a 10 year bull market in equities. Valuations look rich, especially in the US. European equities are still much out of favour. The gap between the most richly valued & the lowliest valued is the highest ever seen in history.
To conclude, the risk of an imminent recession is still low. However, the highly valued companies, the stars in the equity world, could be at risk. In a slow economic environment, they may also face some headwinds. On the other side of the spectrum, earnings have already been revised downwards in the value space and companies look very attractively valued- We are very selective when selecting companies and we select companies with strong balance sheets, strong business models with franchises and we believe such statistics become more and more relevant in today’s environment. Timing the market appears to be difficult for us. Over last weeks and months, the intraday volatility increased, we therefore prefer not to bet as it will only cost long term performance. Overall, such an environment of slow economic momentum is beneficial for value. This is typically should you decompose the economic cycle and see that value starts to outperform.
Bond Yields, a factor out of many…
John Authers is a senior Bloomberg editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of “The Fearful Rise of Markets” and other books. This week he provided a very interesting piece which referred to an analogy of what is happening since Monday and how Isaac Newton foresaw the crash in momentum stocks. “Momentum, the tendency for winners to keep winning and losers to keep losing” is indeed what we saw since the GFC. The gap between value and growth is at unseen levels and we all question the length of this continuous motion. We saw on Monday that value outperformed growth by +3% for the first time since 2014.
According to John Authers the driving factor may sit in the bond market. Coming out of the financial crisis, the 10 year US government bond yield was around 4% by the end of 2009. By the end of August 2019 it was 1,5% from where it went back to 1,8%.
At ECP, we understand the role bond yields play in the valuation models of many market players. We don’t use bond yields as an input in our valuation model. We look more to topics like business sustainability, cash flow, competitive situation etc. These are the true value drivers of any business.
That small spike in yields from 1,5% to 1,8% early September is by some market players seen as an important milestone for the comeback of value investing. In the middle of 2016 the US 10 year bond yield was at 1,5% from where it accelerated towards 3% a couple of years later. In this time period value investors had their days in the sun. European value-equities is one of the one of the most out-of-favour asset classes at the moment. Investing now could turn out to be very fruitful for a long term investor.
What is value investing?
Today Léon Kirch’s article appeared in the AGEFI Luxembourg newspaper. Have a read if you are interested in valueinvesting and want to understand its under-performance over the last decade and why this is about to change!
If you are interested to know more about it, have a read it here
1-0 for Value
This morning our comrade André Huywler from Redbrick Investments provided us with some very interesting food for thoughts, which could lead to the odds of an imminent return of value investing as an investment style.
Since the Global Financial crisis, the outperformance of Growth stocks versus value stocks is tremendous. 2017 was even more successful for Growth as can be seen in the first graph, even with the short “in favour for value stocks” moment end Q4 2018.
Up to now, nothing new here… The second graph however is a closer look at the period from 2017 till now. The leading growth stocks got categorically beaten up by their value contestants by over 3%, which is according to Redbrick the largest one-day underperformance since Q2 2014.
Could this mean that the we are on the verge of an imminent return of value stocks? We are hoping for more crispy news in the upcoming days and weeks which confirms “The comeback of value investing” is about to happen.
“Back to the roots of a proven approach”
Value investors do not believe in the strict form of the efficient-market hypothesis, which says that stock prices reflect all company information. Value investors believe that sometimes companies are underpriced relative to their fair value and exploit the mispricing.
A quality company bought at a discount is always more attractive than a fairly valued quality company. In the long run valuations matter as the stock price will reflect the present value of cash flow generated.
A proven philosophy
An investment strategy that has proven its efficiency over decades and that is designed to be successful in the medium to long term even under pressure to achieve short term results.
Read more about us here
Ready to stand steady
It has become factual that we are in an environment of slow economic momentum and an imminent recession seems not yet on the horizon. The month of August, however, has proven that investors are quite anxious about a serious economic deterioration. Yesterday’s safe investments are not the ones of today, and the ones of today will they be the ones tomorrow?
As a matter of fact, 10 year German government bonds now have a negative yield of 0,6%. We find it hard to call that a safe investment. Currently growth stocks are the Eldorado, but for how long? Investors are extremely sensitive to political noise and Europe remains most affected. We have seen unprecedented outflows from Europe in fund and ETF products since 2018. See below:
Since investor sentiment is correlated to political noise, we need to recognize that it can change very fast. Not-so-bad-as-expected news from Brexit, Italy or US/China negotiations or more central bank measures to boost the economies are each on its own enough to bring some positive in the short run.
It is a waste of time, trying to guess the outcome of all possible events around us and how markets react. One should remain invested in good and solid companies and stand ready to invest more when the window of opportunities is open. We believe that now the window is open.
How much do you pay for growth?
Value Investing continues to make the headlines and not only in Europe. We indeed saw an increased number of publications lately on the imminent death of value investing.
Value stocks are out of favor since the 2007 Global Financial crisis and growth stocks on the contrary are performing extremely well and many expect this trend to pursue in this slow economic growth environment. It has become common knowledge that value stock are trading at a record valuation discount towards its more expensive growth counterparts.
The question raised by most stock market investors is whether this valuation discount in itself is a reason enough to invest into value stocks. As a consequence, we notice the fundamental case for value investing building up. Our base scenario remains that we are in an environment of slowing economic growth where central banks use all the available tools to support economic growth. We are not in a recession, but in a period of slowing economic growth.
Many companies in the value space continue to produce solid free-cash flows as their businesses have slowed, but not impaired. Simultaneously, valuations of some of the growth companies are becoming extremely high and, as a mirror image, the risk of disappointment on growth expectations in a slowing economic environment has increased. Example, Zalando currently trades at 118 times 2019 estimated earnings and the analysts expect earnings to grow at 25% a year over the next 5 years. (source Bloomberg ). Imagine for a second; What will happen to Zalando’s stock price if the German consumer were to cut down on spending?
Keep visiting our page – more to come…
Our investment team
The Investment team has an average experience of 17 years in portfolio management.
Partner, Chief Investment Officer at European Capital Partners (Luxembourg) SA
Allan Jensen, CFA, CAIA
Portfolio Manager at European Capital Partners (Luxembourg) SA
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Learn more about our philosophy
Through its “Entrepreneurial Value Investing” philosophy, ECP provides an innovative approach to the 90-year history of value investing based on a combination of an entrepreneurial thinking with a high conviction, long-term and consistent implementation.
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