Why we’re banking on Europe’s value revival

4 min read 29 Jan 25

In 2024, European value stocks outperformed the broader market, driven by resilient banks despite political risks and rate cuts. We believe the substantial valuation discount relative to US stocks offers a unique opportunity for value investors, highlighting Europe’s compelling case for substantial returns in a dynamic market.

2024 proved to be another positive year for the value style in Europe. Despite a volatile backdrop, fuelled by political risks, growth concerns and evolving views on the direction of interest rates, value stocks outpaced the broader European market and their growth counterparts.

This outcome has defied expectations, as value stocks are generally perceived to struggle in a rate-cutting environment. Although the European Central Bank (ECB) reduced borrowing costs four times last year, the value style has arguably benefited from fewer rate cuts than initially anticipated.

Value’s robust performance in 2024 provides further evidence of the style’s improving fortunes in the past few years. Over three years, value has outperformed growth by a wide margin. Far from being dead we believe European value is alive and well.

The prevailing perception of value investing is often shaped by the US market, where growth stocks, particularly those in the technology sector, continue to dominate. In contrast, the European market presents a different landscape that potentially represents a more opportune backdrop for the value style.

While Europe lacks the same concentration of mega-cap tech stocks represented by the so-called Magnificent Seven (Mag 7), it boasts its own cohort of large-cap growth companies, known as the GRANOLAS1. Unlike the tech-heavy Mag 7, however, these include prominent names in a diverse range of sectors such as luxury goods, technology and healthcare sectors. This distinct market composition underscores the unique dynamics at play in Europe’s value versus growth narrative.

Banks thriving against the odds

Amid the value style’s outperformance in 2024, European bank stocks have risen as surprising victors. Notably, European banks have outperformed the tech-driven NASDAQ, underscoring market confidence in their resilience and adaptability, even amid challenging conditions. This might seem unexpected given the current rate-cutting cycle, but, in our view, the market has overestimated the impact that lower rates would have on their business.

At the beginning of 2024, many sell-side analysts were predicting headwinds for banks. However, we believed that European banks were attractively valued and had undergone significant evolution in recent years. They are now extremely well-capitalised, possess robust balance sheets and have consolidated within the region, thereby enhancing their competitiveness.

In our assessment, banks were acutely aware that rate cuts were on the horizon and have been hedging themselves for this. Coupled with the fact that we do not anticipate a return to another zero-interest rate period in the near future, we think their profitability is unlikely to decline sharply.

In reality, rates have remained significantly higher than investors had forecasted, with the rate- cutting cycle progressing more slowly than anticipated. This environment has afforded banks the opportunity to prepare and adapt. Moreover, banks have continued to benefit from resilient consumer spending and robust net interest margins, particularly in the UK. In our view, we believe banks will continue to surprise the negative investor sentiment.

Leveraging Europe’s market discount

Value has further to go, in our view, to reverse the underperformance of the previous decade: the value opportunity persists. For a start, the valuation discount of the European equity market relative to the US market is exceptionally wide. Across every sector, European stocks trade at a discount to their US counterparts.

For value investors, we suggest this is an encouraging backdrop. Value opportunities are widespread across the market rather than being confined to a few sectors or regions. Value is evident in various countries and sectors, allowing investors to construct diverse portfolios that trade at substantial valuation discounts to US equities. Such extreme valuations, in our view, represent a unique opportunity.

While the US may have more resilient economic activity than Europe, we do not think these factors fully justify the wide valuation gap.

Although the US is home to high-flying technology firms that are driving the AI revolution and companies also benefit from lower energy costs than their European counterparts, we question whether the environment is much better than in Europe. The US also faces its own set of challenges, including a large fiscal deficit and growing debt concerns. Moreover, European banks appear far more attractive compared to their US counterparts.

Despite concerns about the impact of potential US tariffs on European companies, when we compare the two regions, we think the outlook for Europe is not as bad as feared and the discount is not warranted.

We’re in a value world

Despite the prevailing perception that value investing is struggling, in reality, value in Europe and other regions has been thriving. We have observed before that the investment landscape has seemingly changed: we have moved from a world of stability and zero-interest rates to an environment of increased volatility and unpredictability. In this regime, different sectors and stocks are leading the market to those that investors have been used to for the past decade.

“Despite the prevailing perception that value investing is struggling, in reality, value in Europe and other regions has been thriving.”
 

We believe the regime change represents a tailwind for the value style that has potential to endure. The extreme valuation premium attached to the growth part of the market is not justified by fundamentals, in our view, which could encourage investors to rotate toward the cheaper parts of the market.

However, we recognise that there is plenty of uncertainty at both the market and macroeconomic level. Investment styles and market leadership can fluctuate depending on sentiment and macro views. There could well be events or developments that spark a change in market direction and create headwinds for the style.

Nevertheless, we remain optimistic about the long-term outlook for value investing. Value in Europe has been gaining strength since the regime change, although this has not been recognised by many investors. The case for Europe is compelling, especially given the significant valuation discount compared to the US, creating fertile ground for value strategies.

It is time for European value's revival to be appreciated, as such extreme valuations could represent a once-in-a-generation opportunity. That said, we believe it will take time for investors to fully return to value, as it has been overlooked for so long. In our view, the value opportunities are widespread, making this an exceptional time for patient, selective investors to capitalise on the potential for substantial returns.

By Richard Halle, Fund Manager, Value Equities

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.