European equities and value stocks set for positive 2014, says ING IM’s Nicolas Simar
Nicolas Simar, head of the Equity Value Boutique at ING Investment Management, says the next 12 months should be good for European equities and value stocks.
Over the last five years, quality has been given a growth premium and non-cyclicals have seen their weight increased within the growth style. The breakdown of sectors differences between ‘value’ and ‘growth’ clearly highlights the dominance of food and beverage, healthcare and personal and household goods in the growth style those days. These are non-cyclical industries with low and stable rates of growth that make them vulnerable to a European recovery, even a mild one.
ING IM expects the rotation from good quality growth towards value to continue in Europe as bond yields rise while good quality growth companies still trade at an extreme valuation premium relative to value stocks following five years of significant rerating.
At the same time, ING IM predicts some pressure on earnings revision trends. The investment manager notes that those companies – mostly concentrated in industries like consumer staples, consumer durables and health care – typically show underperformance versus the market in a rising rates environment as their equity duration is significantly higher compared to the value side of the market. Furthermore, they share, on average, a significant exposure to emerging market economies that are typically the first casualties of rising US bond yields, as was seen during the first half of 2013.
The same environment of rising bond yields is supportive to the high dividend yield side of the market. High dividend yields stocks in Europe are short duration and have a higher domestic exposure compared to quality growth stocks while low dividend yields stocks tend to underperform their high dividend yield peers in a rising bond yield environment. High and sustainable dividend yields can be found in banks, insurance, energy, utilities, basic resources and construction and material sectors.
As recovery in Europe sustains itself from a very low base, ING IM expects industries such as financials and European exposed cyclicals to benefit from the normalization process in Europe. Contrary to the US market, eurozone earnings still remain 35% below their previous peak in 2007 and are as depressed as they have been at any point over the past 15 years.
Despite this, the investment manager remains cautious on industries trading at all-time high margins, with peak earnings, and that derive a substantial proportion of their topline from emerging markets. Examples can be found in consumer staples, consumer durables, capital goods and chemicals.
Within the eurozone we continue to see value within the periphery as, given the very low base of earnings, we can expect a significant upside potential from peripheral earnings. In parallel, while we recognize more progress needs to be done on structural reforms in the periphery, competitiveness is improving and current account imbalances have been closed over the past few years as export shares of GDP increase.
Cheap valuations in Europe combined with a mild recovery next year support our pro-value, pro-financials and pro-cyclical positioning in European equities for 2014.