The performance gap between value and growth is still significant since the beginning of the year, but growth is starting to catch up. With the Fed on a rate hike course, and with the possibility of a shallow recession in Europe and the US, growth stocks may paradoxically start to outperform again.
Over the past decade, the US equity market has done much better than the European one. Since the beginning of the year, the returns have been more or less equal: the Stoxx Europe 600 stands year to date at a loss of 8.07 percent and the S&P 500 in the States is down 9.15 percent. Under the surface, the damage in the Nasdaq index is even greater. More than 82 percent of the index components are trading below the 200-day average and are therefore in a downtrend.
Over the past decade, the US markets have benefited amply from the fact that 85 to 90 percent of the companies in the S&P 500 consist largely of intangible assets: patents, knowledge, intellectual labour and goodwill. In Europe, it is a lot less. When we look at the sectors within the European indices, we still see a predominance of traditional sectors, such as utilities, telecom and industry, which are rather ‘asset heavy’. This has also affected European stock markets in a world that is increasingly benefiting from digitalisation, network effects and the like. A company like Uber does not have a single car on its balance sheet, AirBnB does not have a single building, and you could go on like that.
America vs. Europe
With high inflation and rising interest rates, with the US 10-year Treasury yielding around 2.17 percent, you would think that Europe, which is more likely to have value companies in its indices, would perform better. Also, business surveys such as the flash eurozone composite indicator for purchasing managers continued to strengthen in February. Headline inflation in Europe is going above 8 percent. So what is missing for an outperformance?
The answer may paradoxically lie in a recession. The IMF has already warned that the conflict in Ukraine will deal a severe blow to the global economy, affecting growth and pushing up prices. According to the IMF, the conflict will affect the economy in three ways: first, higher commodity prices will further increase food and energy prices, putting pressure on incomes and dampening demand. Second, neighbouring economies will suffer from disrupted trade, bottlenecks in supply chains and the reception of Ukrainian refugees. Third, eroded business confidence and increased investor uncertainty will put downward pressure on asset prices.
Europe is feeling the effects of the crisis much more than the United States. The depreciation of the rouble is further fuelling inflation and putting pressure on the European population. From contacts in the US, I hear that American consumers are coping reasonably well with inflation. The middle class is asking for and receiving massive wage increases on a tight labour market, has paid off debt in recent years and has plenty of cash to spend. Energy is the main spillover channel because Russia is a critical source of gas imports for Europe. The US produces its own oil and gas and also supplies defence and weapons. This is positive for their trade balance.
Growth versus value
The carnage in growth stocks since the high in late November 2021 has been unprecedentedly fast and hard. This is basically the correction we saw in the Nasdaq in the early 2000s on steroids. Between 2000 and 2003, the Nasdaq fell by over 80 percent. This decline has been much faster. After the correction, Mister Market focused on sectors with a lot of tangible assets, commodities and energy. The darlings of the past were completely dumped, especially the corona shares and loss-making companies, a forteriori in the mid-cap segment. It was breathtaking to see companies worth hundreds of billions of dollars decimated in a matter of weeks.
In 2021, everyone accepted valuations of 30, 40 or 50 times price to sales without a problem. Today, no one wants to see secularly growing companies at a price to sales of 10 to 15 times. That is just the manic-depressive Mister Market, who is in a depressive phase again.
The performance of growth in recent years has been almost one-to-one with quantitative easing. Now that easing is ending, you would think growth would underperform. But Mister Market looks ahead. There has already been a 50 to 90 percent correction in growth.
The IMF is likely to lower its growth forecasts in the coming weeks and months. The “tightening” narrative will also fade into the background with more uncertainty. The US yield curve is about to invert. This may revive the growth narrative, paradoxically in a recessionary environment, true to the adage “when growth is scarce, growth is expensive”.
This article was originally published in Dutch on InvestmentOfficer.be.
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