Value investors in Europe have outperformed in the last two years compared to the US, which is unusual. This is because the improving European economy contrasted with a disappointing US economy. As a result, investors favored growth stocks in the US and value stocks in Europe, leading to divergence in valuation spreads between the two regions. Looking forward, the document argues that leading indicators now point to better conditions for value stocks, including increased inflation expectations and a positive economic surprise index. Valuation spreads remain high in the US, signaling potential for value stocks to rebound there as well as in Europe.

1. Value investors in the Eurozone have done well
over the last two years, but quite poorly in the US.
This is rather exceptional, as style returns
generally move in similar directions across these
two regions. Indeed, their economic dynamics
are often alike. This time, the improving health of
the European economy contrasted with a
disappointing US economy. (By means of
example, the last two years the US Citi economic
surprise index has been negative on average,
while it has been comfortably positive for the
Eurozone).
For the US this meant that investors flocked into
quality growth stocks -think FANG- to position
themselves for a decelerating US economy, while
in the Eurozone they preferred value stocks. This
made that valuation dispersion diverged. In the
US, it rose to well above the historical average,
while in the Eurozone it fell to a bit below the
average.
The behavior of the economy compared to
expectations will again be important. Since the
case for the US value is more contrarian than the
EU because its underperformance has been so
significant. In fact, the six months rolling excess
return has rarely been as negative as today.
The buzz around the US tax reform proposals
have reignited the reflation trade a bit, but all in
all, it remained quite modest. Inflation
expectations have increased, but are still well
below the level of the beginning of the year and
value stocks outperformed during the month of
September, but not a lot compared to where we
are coming from. From that perspective, we
expect a further rebound for the following
reasons:
• Valuation dispersion (the spread in valuation
between the cheapest and most
expensive stocks of each sector, see graph)
• Leading indicators are at good levels (see
graph)
• On-line inflation is spiking
• The surprise index is finally positive again.
As value stocks typically do well around the turn
of the year, seasonality can help also. Whatever
the reason -portfolio re-risking, window dressing,
tax-loss-selling and so on,- the outperformance
has been remarkably consistent. That argument
goes for both the US and the Eurozone.
In sum, we believe there are good reasons to
assume that after a longer period of
outperformance of growth stocks, value stock will
stage a comeback. Valuation dispersion, sound
leading indicators, spiking on-line inflation and a
positive turn in the surprise index are the main
reasons that it’s time for value.
Source: DPAM
Valuation dispersion
Source: Institute for Supply change, Markit and Nomura
Manufacturing PMI
Now, what do we expect for Value stocks from
here on onwards?
Time for Value?