John Bennett, Director of European Equities, discusses growth versus value, whether he believes inflation will become more persistent and what this means for European equities.

    Key takeaways

• The valuation of growth stocks has been stretched to extreme levels. We believe this provides an opportunity for the value stocks which have been left behind.
• It is important not to become rooted in a single and one-sided view on inflation. Our view is that inflation will be ‘transitory’ for longer at the very least.
• History proves that you cannot control bond markets and we would be unsurprised if the bond market gets spooked.

Transcript Expand

I think the key factor in markets, not just in Europe, equity markets over the summer of 2021, has been the resurgence, resumption of growth versus value and those two styles. There’s been another, I think, surge of outperformance by growth stocks versus value stocks. That is undoubtedly a headwind for us. We’re not deep value, nor are we full-fat growth, we’re always a blend style, but undoubtedly we are tilted more towards value than we are growth.

And actually, I think if you look over the summer months and then with the summer coming to an end, and perhaps we’ll come on to this, but I actually think it’s created a real opportunity for investors in Europe. As the summer came to an end the extension, or even the stretch of the elastic, in terms of the valuation of growth stocks, I think, has gone way, way, way too far. And I actually think the vulnerable part of markets right now, and I would actually say extremely vulnerable, is highly rated growth stocks. I see a big opportunity as we speak on the other side of that.

The premium that people are paying for so-called ‘safety’, so-called ‘growth’, so-called ‘quality’ is extreme. And you can lament that and sometimes I do lament that and go, what are they doing, why are they paying ten times sales, 15 times sales, 40 times earnings? And I have watched stocks, a certain cohort of so-called growth stocks go from 25 times earnings to 35 times to 45 and 55 times earnings. And I think we’ve entered realms of madness in some of those names. And it’s quite a big cohort.

Now you can lament that, and there are times I lament it, but you can also get a wee bit excited at the other side of it. And that is to buy, I don’t want to say the remainers, because that has all sorts of other connotations, but the remainders. Those left behind in unfashionable areas. I think the single biggest opportunity I see and it’s probably why I’m… This is me excited, incidentally. But it’s probably why I’m more excited than I usually am. I see a giant opportunity in European value.

And that is interesting because it always comes with its challenges. The value-conscious investor, which I’ve always seen myself to be. And actually, the winners in recent times have been the value-unconscious. But the value-conscious investor, like myself, I think has a terrific opportunity in European value. One of the challenges to a value investor or the value conscious is you have to patient and you have to be prepared to be lonely because you often have to be contrarian. Bring it on. I’ve been lonely many times in my investing career. It is.

And I actually think you’ve got entrenched strategists, entrenched economists, entrenched market observers, entrenched fund managers, entrenched stock pickers. And when you get entrenchment, you’ll get…the entrenched will argue their views. The value managers will say, the deep value managers might say, here comes inflation, it’s coming. And the entrenched growth manager will say no, listen to the bond market, it’s all fine, come on in, the water’s warm. And I’ve always said, never become entrenched. Never become polarised.

My position is, at the very least, it’s transitory for longer. And when does transitory not become transitory? And please, let’s not forget that the bond market… We’re in an environment right now where everybody has faith, misplaced or not, faith in central banks to control the narrative, to control the bond market. Let’s not forget that history shows that… as somebody, I’ll say this unfashionably, but somebody I revered, really unfashionably, given that I came from Glasgow. Somebody I revered Margaret Thatcher once said you can’t buck the markets, ultimately they will buck you. And the bond market is a proven master of bucking you.

In other words, what I’m saying is, don’t be surprised if the bond market… And it’s not a forecast, but we shouldn’t be surprised if the bond market gets spooked and shows that central bankers are actually not in control. You can never be in control of markets, markets control us. Not the other way round. So, I wouldn’t be too surprised if markets were to start worrying about transitory for longer, i.e. inflation is hardwired in the system and could we be sat here in a year’s time, autumn 2022, and inflation prints are still higher than people expected. If that’s the case, and long before then, you could easily get a spooked bond market. That would be fun.