The macroeconomic environment and its uncertainties have predominantly reigned over the equity markets in the past eight years. From the sweeping financial crisis triggered by subprime mortgages to unconventional monetary policies implemented by the central banks of the world’s major developed economies, not to mention global growth driven mainly by emerging countries, the major political crisis in the euro zone… all are unprecedented macroeconomic developments that have skewed investor preferences toward bonds, reaching unprecedented yield levels and toward equities offering high visibility, high dividends or strong links to growth in emerging countries. Also, the tightening of regulations in a bid to prevent another financial crisis has to be factored in. As far as equity investments are concerned, this situation naturally favoured “growth” style investing during these years of financial crisis, as shown in the chart below:
Events that have unfolded since summer 2014 – collapse of oil prices, falling inflation rates, slowdown in emerging countries ( whether or not commodity-producers ), recovery seen in developed countries (albeit a timid one) and significant changes in exchanges rates – mark a clear departure from the economic trends in place since 2008.
Unfortunately, macroeconomic trends are very often hard to predict, while resulting volatility in equity prices is often extremely disconnected from industrial valuations.
Chaotic conditions over these long years have not stopped US companies from generating unparalleled margins and European companies from achieving much higher margins compared to the trough in the 2002 economic cycle, despite a weak economic recovery and a major political crisis. As Value investors, we are always looking to seize the opportunities that arise in such periods of deep uncertainty and subsequent volatility. Against such a backdrop, European listed companies have had to cut costs, overhaul their entire manufacturing process and revise their business portfolios, very often becoming world leaders and hence essential in their field Macroeconomic fluctuations as well as investors’ concerns have at times sent their stock prices plummeting. In some cases, these prices are completely decorrelated from their industrial valuations.
Valuation discounts appearing today as a result of fears of a slowdown in emerging countries are excessive in the case ofLinde and companies in the luxury goods sector (LVMH,Kering), as well as companies such as Rémy Cointreau orBMW.
Revived fears on the financial sector (Italian banks, or banks exposed to the mining and oil sectors) also looks overdone in light of the considerable capital improvement efforts undertaken in the banking sector as a whole, including Italian banks.
Oil majors, which have hit rock bottom in terms of profitability and valuation, are demonstrating unprecedented adaptability in their capex, matching the magnitude of the oil price collapse plaguing the industry and hence providing a very genuine investment opportunity.
Conversely, the top three sectors outperforming the Stoxx 600 since the advent of the financial crisis (healthcare, food & beverages, and home & personal care products) have never reached such valuation peaks, as they also are disconnected from their historic industrial valuation despite being “great companies.” These sectors, representing about 1/3 of European listed companies, may well see their valuations suffer should new macroeconomic trends arise.
Times of strong uncertainty with regard to future macroeconomic trends (strength of US growth, contradictory macroeconomic indicators, inflation, Fed interest rate hikes or not) are often sources of volatility, but also opportunities and subsequent outperformances for Value investing. True as always to our investment process, we will continue to seize and to prepare for such opportunities.
This article has been excerpted from a recent letter of Metropole Gestion.