Traditional value European sectors such as Autos, Insurance and Banks are priced near the cheapest levels in two decades according to an equity research note from Barclays’ European Equity Strategy team.
The cheapness of European value stocks has existed for many months already, and it is a trend that Barclays’ equity strategy team has flagged up already several times this year. However, during the past two months (since Brexit) European value stocks have continued to underperform both growth and the wider market taking valuations further towards oversold territory compared to historical norms.
So far, the top quartile of value stocks has underperformed the equal weighted benchmark by about 4%. These declines have only made value more attractive compared to historic norms. The forward P/E ratio of value versus expensive stocks in Europe is at its lowest level since the financial crisis. Sceptics will say that the reason why value is so cheap compared to other styles is its overweight towards financials, where multiples are currently quite low. However, Barclays finds that on a sector-neutral basis (adjusting for sector weightings) the discount on value stocks relative to the most expensive stocks in the market is now near financial-crisis lows.
What’s the value catalyst?
Cheap stocks can get cheaper still and as we’ve already seen already this year, just because value trades at a discount to growth it doesn’t mean the valuation gap is going to close anytime soon. That being said, the analysts over at Barclays believe that value’s streak of underperformance could be about to end as the Federal Reserve continues to raise rates.
Indeed, according to the analysts at Barclays, over the past decade and a half, the performance of value has been driven by the US 10-year Treasury yield and inflation expectations. Why the 10-year Treasury? It appears that equity investors look towards the US 10-year yield as a better representation of prospects for global economic growth and, by extension, earnings. It’s is the view of Barclays’ analysts that US inflation will pick up in the next few months, which will ultimately translate into higher returns for value stocks:
“The 6m growth rate on core CPI has been at least 2% in every reading this year, led by the services sector. Secondly, the drag from core goods inflation is abating. The July reading on ex-petroleum import prices of -1.3% y/y was the least negative since January 2015. Thirdly, wage growth appears to be accelerating. The latest employment report shows that y/y average hourly earnings growth for production and non-supervisory workers was the strongest since January 2010. This supports our inflation strategists’ view that and that overall core inflation should persist above 2%. Taking things in the round, inflation breakevens could perk up, thereby driving a re-rating in Value stocks.”