Many investors believed the dot com bubble was a one-off, with never to be repeated dispersion in valuation within the equity market.
In European equities today the gap in valuation between value stocks and growth stocks has now marginally eclipsed the March 2000 peak.
Below we show two non-cyclical measures of value: price to book and price to sales. These charts use MSCI Europe Growth vs MSCI Europe Value with data going back 25 years. Each chart shows the premium in the market for growth equities over value equities in percentage terms since 1995. We show the mean over the period with standard deviation bands either side. Today growth is approximately 3 standard deviations more expensive than value. In absolute terms the price premium is more than double the 25 year average.
If we look at cyclical measures of value, incorporating forward earnings estimates, the picture is similar, with growth equities approaching 3 standard deviations more expensive than value equities. In absolute terms once more the premium is more than double the average since 1995.
This historical context shown in the charts above is important in helping navigate the recent volatility between value and growth. Since mid-August 2019 value began outperforming growth in Europe, performing strongly in September and October. But it has started the year on a weak note.
What might be driving the recent expansion in the premium for growth stocks?
It is possible that the drop in value versus growth is front running a large drop in bond yields that is about to materialise. This cannot be ruled out, but more likely technical factors are playing a role.
At the start of the year many investors make changes to portfolios and add cash. Investor sentiment has improved sharply over recent months and cash balances have fallen. When sentiment changes quickly, momentum strategies can benefit. Fast flows have likely poured into the winners of the last 12 months, supporting expensive growth and hurting value. Given the record dispersion and limited fundamental support, this phenomenon should not last long.
The LF Lightman European Fund has strong earnings growth expected in 2020 and 2021 with an EPS CAGR of 9% over the period. The fund has a forecast dividend yield of 3.91% in 2020 and 4.32% in 2021, with a median PE of 13 this year, and 11 next year.
The premium for growth stocks and the discount for value stocks in European equities today has no historical precedent. This record polarisation should be exploited. The recent dip for value should be viewed as an historic entry point.
Sources:
Bloomberg
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