Value in Europe or growth in the USA - or both?

It seems like the global equity market cannot get rocked by anything. The MSCI ACWI Index is up over 20%  year to date (as at 15 November 2024, in euros). Once again, the US equity market is the driving force behind this move. Equities outside the US - i.e. the MSCI ACWI ex USA Index - are “only” up 12%. Particularly striking is the divergence in performance since the beginning of October, possibly due to the potential disadvantages that the US's trading partners could face as a result of the expected increase in tariffs by the new US President Donald Trump, among other things. 

Performance of the global equity market with and without the US, in % (EUR)

Past performance is not a guide for future performance.

^{Source: Morningstar, 15 November 2024.}

Another interesting observation is the different development of the individual market segments within the regional  equity markets. For example, while growth stocks are clearly ahead in the US year to date, the picture is exactly the opposite in Europe. Here, value stocks are enjoying a tailwind and are therefore clearly ahead of growth stocks. For investors who structure their portfolios regionally, it is therefore worth taking a closer look at the individual regional equity markets.

Total return of value and growth stocks YTD, in % (EUR)*

Past performance is not a guide for future performance.

^{Source: Morningstar, 15 November 2024. *Based on the respective MSCI indices.}

As interesting as it may be to look at past performance, much more important are the expectations for the future. While, in retrospect, the different developments are not really unfounded - earnings growth in the US was simply higher than in the rest of the world - the two crucial questions for today's investment decision are what to expect in the future and what expectations are already priced in. The second question can  be answered, at least roughly, on the basis of valuations.

What do current valuations tell us?

Valuation multiples, such as the forward P/E ratio (P/E ratio based on expected earnings over the next 12 months), can be compared from different perspectives. For example, you can look at the valuations of different markets relative to each other or relative to their own history. The latter view currently reveals three conspicuous features (see chart below): 

• The US equity market appears very expensive compared to its own twenty-year history (premium of 37%). Valuations in Europe, Japan and emerging markets look much more moderate.
• Growth stocks are expensive everywhere compared to their own history, but they appear particularly expensive in the US (premium of 62%!), followed by Europe (premium of 32%) and emerging markets (premium of 19%).
• Value stocks, on the other hand, still look cheap compared to their own history, especially in Europe (discount of 9%) and Japan (discount of 8%).

Valuation premium/discount relative to 20 year history by region*

^{Source: Refinitiv Datastream, 31 October 2024. *Based on the respective MSCI indices and fwd P/E ratios (NTM), Data from 30.11.2004 to 31.10.2024.}

Of course, this generalized view is very simplistic and often does not reflect the situation of individual  stocks within each market. Nevertheless, in my opinion, one can at least  sense how much optimism or pessimism  may be priced into a given market.

US equities with very high expectations

Judging by valuations, markets seem to be expecting rosy times ahead for US equities. In order to justify a valuation premium of 37%, future earnings growth would have to be significantly higher than the already strong earnings growth of the past. Given the often high quality of the dominant US companies, this does not seem impossible, but there is little room for disappointment.

Nevertheless, I believe that investors should face the fact that many US companies are global leaders in their respective business areas. When it comes to major technological innovations in particular, it is hard to imagine them without the US. Companies such as NVIDIA, Microsoft and Alphabet are unlikely to let anyone steal their thunder when it comes to AI. Their market position is simply too dominant and their financial power too great. In addition, new companies are regularly emerging from the US that are characterized by innovation and are highly successful in marketing their products globally. In my view, completely ignoring this innovative growth potential in a global equity portfolio would be misguided.

However, simply buying US growth stocks blindly would also be too easy. Selectivity is required, as not all expensive US growth stocks justify their high valuations. Many of these stocks may simply be riding the wave of euphoria around certain growth themes. In these cases, the potential for a setback can be very high if the market realizes that the companies may not be among the winners in their thematic areas after all. However, a certain - albeit not arbitrary - valuation premium may well be justified in the case of high-quality winners – provided they can be identified with some degree of certainty.

Value stocks in Europe with catch-up potential

The nice thing about value stocks with low valuations is that expectations regarding future earnings growth are generally very low. This means that future business performance does not necessarily have to be excellent for such stocks to generate decent returns. If the pessimism is great enough and the valuation is correspondingly cheap, low growth is often enough to provide a positive surprise.

As shown above, value stocks in Europe currently enjoy a tailwind compared to growth stocks. However, this tailwind did not just start this year, but was already evident in the two previous years. Since 1 January 2022, the value segment in Europe has  delivered a cumulative performance of almost 30%, while European growth stocks are barely in positive territory with an increase of around one percent in the same period (as at 15 November 2024, in euros). 

Performance of European value and growth stocks since the beginning of 2022, in % (Euro)*

Past performance is not a guide for future performance.

^{Source: Morningstar, 15 November 2024.}

Although value stocks have already caught up in Europe, there is still a clear valuation anomaly. In contrast to European growth stocks, which are still around 30% more expensive than their 20-year median, valuations of value stocks are still almost 10% below their  20-year median. In other words, the market appears to be relatively pessimistic for the value segment, but at the same time quite optimistic for the growth part of the market. Given this valuation anomaly and the price momentum in favor of value, it may be worth looking at the cheap value segment, particularly in Europe, despite the macroeconomic headwinds of slowing economic growth and the uncertainties surrounding a second Trump presidency. After all, where a great deal of pessimism has already been priced in, the potential for positive surprises is correspondingly high.

However, as with US growth stocks, stock selection is crucial here as well. Just because a value stock has cheap valuation multiples does not mean it is automatically undervalued. There are many value stocks that are cheap for good reason. These so-called “value traps” should be avoided wherever possible. An in-depth fundamental analysis, which examines the strength of the balance sheet, the longevity of the business model and management behavior, among other things, is critical. Those who succeed in excluding such value traps should have a clear path to the top.

The question is not “either growth or value?” 

Different regional equity markets often have different characteristics with different opportunities and risks. In a global equity portfolio, one should therefore have a closer look at the individual regions. Ultimately, you may well come to the conclusion that growth stocks in one region and value stocks in another region look attractive for different reasons. In my view, a  sound global equity allocation is therefore not necessarily a matter of style between value and growth, but can be a combination of both, depending on market conditions.

The value of the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast.