European mega-caps have lagged behind mid-caps since 2000, but with lots of investors still shaken by the crisis and fears that some companies could still go under, the conditions for pre-2000 mega-cap outperformance could come together again.
The outperformance of Europe’s mega-caps
“Strong flows to equities supported the outperformance of Europe’s mega-caps in the mid-to-late 1990s. Driven initially by the convergence trade across Europe ahead of the introduction of the euro, investors poured money into European equities with a ‘liquidity first’ mandate,” says a Citi report written by analysts Anna Esposito, Mert Genc, Jonathan Stubbs, and Ayush Tambi. But from 2000 on, “mega-caps have not offered investors enough growth to attract net flows from the rest of the market. Instead, mega-caps have often been used as a source of funds by investors, including hedge funds.”
All mega-caps have underperformed the market?
It would be a mistake to think that all mega-caps have underperformed the market. There are plenty of good quality firms at this size, and excluding 2010, at least 40% of mega-caps have outperformed, so stock picking at this size has remained a viable strategy.
But there could be an even bigger opportunity just around the corner. Investors who got burned by the crisis (which, frankly, is most of them) are going to look for strong balance sheets and liquidity in Europe over the next few years in case the economy there backslides. You can already see this in places like Spain and Greece, where funds are eager to take advantage of incredibly low equity prices, but they are putting money into larger national firms, not mid or small-caps.
The only piece that’s missing for a 90’s style mega-cap rally is a large influx into European equities, but the combination of a European recovery and greater than expected fallout from tapering could make it happen. Emerging markets got a reprieve from tapering in September, but it’s pretty optimistic to think that India or other countries with trade balance issues will sort them out in the next couple months. And if tapering hits the U.S. equities markets harder than expected, Europe could suddenly be the equity market of choice.
“Strong balance sheets, attractive/cheap valuation and reasonable fundamentals have not prevented poor performance from the mega-cap group,” says the Citi report, but those attributes could become a lot more attractive in a post-QE world.