European Value theme looks tactically overbought, though looks attractive from medium / longer-term perspective, reports Morgan Stanley.

Krupa Patel and the team at Morgan Stanley (NYSE:MS), in their recent European Equity Strategy, state that the recent pace of Value theme’s outperformance is now historically significant and hence valuation dispersion is beginning to normalize.

European value: more discrimination at stock level

Morgan Stanley analysts point out a more mixed short-term outlook for European Value theme suggests that investors should discriminate more at the stock level.

In May 2013, Morgan Stanley was overweight in European Value as the macro backdrop remained supportive of Value with Value remaining attractively priced relative to growth. Together with relative ROE of MSCI Europe’s Value index rising relative to its Growth Index, this would catalyze Value’s relative performance.

However, Morgan Stanley (NYSE:MS) now believes with the recent strong run, European Value theme looks tactically overbought and hence a period of consolidation is likely. Some of the reasons to justify hesitation after the recent Value outperformance would include: (a) the 3-month outperformance of Value over Growth is now comparable to the recovery years of 1983, 1993, and 2003, (b) Valuation dispersion has narrowed in recent months and is now back in line with the historical median and (c) 62% of Value stocks have outperformed the market over the last 3 months.

As can be seen from the following graph, the relative performance of Value vs. Growth is now 2 standard deviations above its 12 month rolling average:

European Value Vs Growth

Eurpean Value: stocks offering compelling long-term argument

Krupa Patel and team at Morgan Stanley suggest investors should discriminate more within Value names by booking profits from those stocks where it is increasingly hard to justify the recent re-rating, while taking a long call on those supporting a compelling long-term argument.

The Morgan Stanley team has identified the following six overweight-rated stocks where the analysts feel the recent rerating is justified besides offering further upside potential.

Topping the overweight list is Metro where the analysts see substantial scope for a self-help operational turnaround and portfolio optimization. Morgan Stanley analysts also assign overweight rating on Orange SA (ADR) (NYSE:ORAN) (EPA:ORA) with steep price declines in mobiles already priced in, besides Orange is able to maintain the € 10 per month premium on handset plans. The analysts are also overweight on Renault SA (EPA:RNO) (OTCMKTS:RNSDF) as they feel the company is ideally positioned to benefit from a recovery in Western European Union volumes. Morgan’s analysts also like Banco Santander, S.A. (ADR) (NYSE:SAN) (MCE:SAN) as it is well-positioned to benefit from accelerating NII growth in Spain and the UK. The analysts assigned overweight on Veolia Environnement SA (ADR) (NYSE:VE) (EPA:VIE) as they believe it is the most attractive turnaround story within European Utilities. With the market’s longtime desire for structural change at the company starting to be fulfilled, the analysts are overweight on Vivendi SA (EPA:VIV) (OTCMKTS:VIVHY) as well.

However, Morgan Stanley analysts have identified the following six stocks as underweight / equal-weight rated stocks as they feel the recent re-rating is unjustified and hence these stocks may be due for a pull-back. These six stocks are Antofagasta plc (LON:ANTO) (OTCMKTS:ANFGY), ArcelorMittal (ADR) (NYSE:MT) (AMS:MT), Axel Springer AG (ETR:SPR) (FRA:SPR) (OTCMKTS:AXELF), CRH PLC (ADR) (NYSE:CRH), Deutsche Telekom AG (ADR) (OTCMKTS:DTEGY) (ETR:DTE) (FRA:DTE) and Saint-Gobain Oberland AG (ETR:OLG) (FRA:OLG).