“One implication of Trump could be a catch-up trade between Europe and the US,” said Andy Evans who, admittedly, is a European equity fund manager at Schroders. Evans, speaking at an Expert Investor forum in Bilbao last week, argued that European equities are set to benefit from inflation in relative terms, because the European equity market is more value-oriented, while US equities are tilted to growth.
“You could debate whether the growth versus value debate is a bit of a fallacy or not, but ultimately if we do see rate continue to move higher, value will continue to outperform growth,” said Evans. “In that environment, you probably should lean towards lower quality European companies instead of the very tech-heavy US equity market,” he added.
Growth companies, which tend to have high P/E ratios and whose earnings are often projected further in the future than those of value companies, are more susceptible to rising interest rates because their future earnings will have to be discounted at a higher rate. During the previous Fed rate hiking cycle, that lasted from 2004 to 2007, value equities clearly outperformed growth stocks.
“You have seen the US equity premium gradually edge higher, so a Europe catch-up trade is beyond the obvious,” the European equity manager concluded.
Expensive Google
Google, or Alphabet as its holding company is called these days, is one of those American growth companies that trade on a premium [the current P/E is 30.46 according to Nasdaq], believes Holger Wehner of Allianz GI.
“Google is a fantastic company, but I struggle with the valuations. So we have moved to parts of the market that are cheaper as part of this shift from growth to value. Google might still do well, but it’s probably not going to be reflected in the share price because this growth is already priced in,” he said. On average, analysts forecast Alphabet to produce 15% earnings growth in 17%.
Fund selectors attending the forum in Bilbao have, like Wehner, a preference for value over growth in US equities. In European equities however, they prefer growth.
Generally in Europe, European equities have a lot more fans than profitable but expensive US stocks. In every European country, European equities have the edge. A recent, Pan-European Expert Investor poll showed a majority in favour of increasing their allocation to European equities over the next 12 months, while sentiment towards US stocks is neutral.
So far this year, the Trump trade has lifted all boats. But as soon as Trump will disappoint, and it’s difficult to imagine he will not, the chaff will be separated from the wheat and volatility will rise. US equity markets recording their first loss of more than 1% in on Tuesday may be a sign that moment will come sooner than later. After all, a lot of money has flown into equities of late.
“This hot money will exit if we have periods of volatility as the market has been driven by a positive view of policy developments,” said Eric Papesh, a US equity investment specialist at T Rowe Price.
