Investors head to European value stocks as yield risk intensifies
By Jenni Reid
13:20, 21 January 2022
European equity funds have seen strong inflows so far this year, with value stocks holding particular appeal as central banks begin rate-hike cycles and global bond yields rise.
Inflows to Europe-based funds totalled $1.9bn (£1.4bn) last week, taking the year-to-date total to $3.1bn – the strongest early year performance since 2018, according to new figures published by Bank of America Global Research this week.
This has been driven by $2.8bn inflows into passive funds, versus $0.3bn into active funds.
Last week, financial stocks recorded the largest inflow at $1bn, with only telecoms seeing an outflow, at $0.1bn. The majority of the money – $0.3bn – went to Swiss funds, while the UK saw the largest outflow, of $0.4bn.
The MSCI index of value stocks has risen nearly 5% in the first three weeks of the year on a total return basis, versus a 5% decline in its worldwide measure of developed market equities, the Financial Times reports.
Rate raises
“Tighter monetary policy and rising bond yields are shaping up to be key drivers for the equity market in 2022,” writes quant strategist Paulina Strzelinska at Bank of America, noting that 50% of respondents in its 18 January Global Fund Manager Survey are expecting the US Federal Reserve to hike rates three times this year.
Jim Caron, head of macro strategies, global fixed income at Morgan Stanley Investment Management, told CNBC the market is now pricing in four or more rate rises this year.
Last month, AXA Investment Managers predicted most central banks will start raising rates through 2022, with South Korea, New Zealand, Canada and the UK among the countries to kick off.
Stock impact
Higher rates may weaken the appeal of high growth and tech stocks.
As Pierre-Yves Gauthier, head of strategy at AlphaValue, told Capital.com: “A rate increase means that all other things being equal, the future cash flow will be discounted at a higher rate, ie, their present value will be lower.
“Growth stocks are stocks for which a large part of net present value [NPV] is derived from cash flows that will come say 10 years or more, while for a value stock, most of the NPV derives from CF that will come in the next few years.
“All things equal, a higher discounting rate will impact more cash flows in the far future than in the near future. It is therefore logical that in a rising rate environment, growth stocks be more penalised than value, hence triggering a rotation from the former into the latter.”
This may explain an outflow from the US to Europe, Gauthier said.
“Inflationary pressure is more acute in the US than in Europe, with the UK in between, being once again the bridge with one foot in Europe and another one in the US.
“The FED is clearly on a tightening path while the ECB [European Central Bank] is still on the fence. Rates are therefore higher in the US (1.75% currently) and year to date have been rising faster than in Europe, even if rates have increased everywhere.
“Investors may be tempted to sell US to buy European equities, even more so since US stocks are naturally more skewed towards growth than European stocks.”
Volatility ahead
“Relative long-term valuations are more attractive in Europe vs the US, and the recent sell-off in the Nasdaq will have spooked investors into looking for alternatives,” Emma Wall, head of investment analysis and research at Hargreaves Lansdown, told Capital.com.
Yesterday, renowned investor Jeremy Grantham said the US was approaching the end of a pandemic stimulus-fuelled “superbubble” across stocks, bonds, real estate and commodities.
After criticising the Fed for allowing the bubble to develop and warning of the pain to come, GMO co-founder Grantham advised: “A summary might be to avoid US equities and emphasise the value stocks of emerging markets and several cheaper developed countries, most notably Japan.”
“Investors should be mindful that volatility across all regions will be increased this year. In the US we have already begun to see this volatility increase – the year has started with a bang for US stocks, particularly growth and tech names,” said Wall.
“The market response to the end of stimulus and the Fed raising interest rates at a faster rate than anticipated has been negative. Markets do not like uncertainty, so there is an argument that signposting rates rises and central bank policy should be enough to tighten without price disruption. But inflation remains a problem, and valuations are high across the pond despite the recent sell-off.
“The combination of these factors mean it is highly unlikely 2022 will produce the same returns for US and indeed global equities as 2021.”