Eurozone value ‘cheapest in decades’ says ING IM’s Nicolas Simar
Nicolas Simar, head of Equity Value Boutique at ING Investment Management believes a drop in tail risk and undervaluation of European and eurozone equities will drive a rerating of value stocks in the region.
With improving macro momentum, ING IM believes it is time to leave the so-called secure and defensive growth side of the market and add to the more eurozone domestically exposed type of companies in cyclical and financial industries.
Following a 30%+ underperformance versus the growth side of the eurozone market over the last five years, value has not been this cheap since the TMT bubble in 1999.
European and eurozone equities are cheap. Everyone agrees on this. The cyclically adjusted PE ratio is at a 40 year low in Europe and the 30% discount versus the US market on the same metric is substantially higher than the 10-15% long term average European discount. Besides this, while US earnings are 20% above previous 2007 cycle peak, European earnings remain 30% below that same cycle peak, leaving ample room for European earnings to close the gap.
Although European equities are currently cheap, they are not valued equally attractive. On the one hand, more internationally exposed ‘secure consumer assets’ (consumer staples and durables), have been rerated significantly over the last five years because of investors’ search for secure and stable growth assets.
The rerating of this side of the market has pushed its relative valuation close to a 20 year high – with little value left. However, on the other hand, companies which are more exposed to the eurozone suffered an important derating having been impacted by the eurozone and sovereign disaster that followed the 2008 financial crisis.
As a result of these trends, the eurozone’s valuation dispersion has risen to a 15 year high, leaving the value side of the markets at highly cheap valuation levels. European financials, domestically exposed cyclical companies trading at trough multiples offer significant undervaluation. However, ECB president Draghi’s speech in the summer of last year removed, or at least reduced eurozone tail risk significantly and was a necessary condition to make the eurozone viable again for international investors.
In order to reverse the 30%+ European value/growth gap that has been created over the last five years, more is needed. Besides the eurozone’s tail risk reduction, positive earnings momentum and GDP stabilisation across the region are required. Improved recent macro data in Europe, including rising PMIs in the periphery, do show that the eurozone has left the recession phase of its cycle. As Europe is in the early stage of a recovery, a 1.5% GDP growth next year can easily support a 10-15% earnings growth in 2014.
In short, attractive valuation, improved eurozone macro data and positive earnings revision leave plenty upside room for the value side in Europe.