Sector rotation in favour of value investments
di Alessia Argentieri
Against a backdrop of highly volatile markets, subject to unpredictable movements not justified by economic fundamentals, value stocks remain particularly out of favour with investors, according to Nicolas Simar, portfolio manager for the Equity Value Strategy at NN Investment Partners.
However, Simar believes that opportunities are emerging as the gap widens in each sector between the cheapest stocks and those with the highest price-to-book ratios. While long-term US interest rates have been falling since November 2015, due to the economic slowdown in emerging markets and doubts about US growth, historically there is evidence for a positive correlation between the rise in long-term US rates and the relative performance of the value style. According to Simar, the current valuation of value stocks clearly indicates that markets are expecting a significant slowdown in activity, while at the same time growth stocks are trading at elevated levels.
Nicolas Simar, portfolio manager for the Equity Value Strategy at NN IP , explains the impact of the dispersion in valuations: "This gap in relative performance between the two styles, value and growth, has not been this large since 1999. After the technology stock crisis we saw value stocks outperforming the market for several years. If we continue to see a distortion in valuations investors should expect to see a rotation in favour of value stocks, most likely happening this year."
Simar continued: "Since the beginning of the year, the value style has performed in line with the market developments in Europe. In the US, it has slightly outperformed the main indices. As such, while not the consensus view, we believe that the value strategy offers a real opportunity for investors."
This dispersion between the value and growth investment styles was the most striking development over the last six months for the NN IP High Dividend strategies. Value performed poorly in 2015, and dividend-based strategies were no exception. The dispersion between value and growth was huge and ranged from 7% in emerging markets to as much as 15% in Europe. The most important reason for this divergence was investors' continued preference for quality growth stock positioned in the consumer and healthcare sectors, to the detriment of undervalued stocks in energy, materials and banking sectors. While underperforming versus the standard broad benchmarks, the High Dividend funds outperformed the value benchmark significantly, with the US strategy as an exception.
In evaluating specific stock sectors, NN IP highlights the case for banking stocks offering good entry points for investors, despite market doubts about their financial strength. Having direct exposure to the credit cycle recovery in Europe means that as economic activity picks up so too do the opportunities presented by banking stocks. While within cyclical value, those companies with more exposure to European domestic demand are favoured, with a bias towards the construction and transportation sectors. These stocks offer a real potential to increase dividends in case of further recovery in Europe. Conversely, caution prevails on stocks with the largest exposure to global economic conditions and the activities of emerging countries.
Simar added: "As markets remain volatile, NN IP encourages investors not to give in to panic. The market has already anticipated a decline in activity in Europe, however, if a decline in global growth emerges, the value side of the market should offer some form of downside protection (as it has been the case during the last two recession phases of 2000-2002 and 2008-2009). With this in mind, in case of a rebound, stocks with the biggest discounts should be taken into consideration by investors."