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Boutique insights: Is the market opportunity moving from the US to Europe?

Three top-performing local boutique managers give their view on a potential rotation out of US equities into Europe.

At the start of 2014, US-listed stocks had a weighting of 54.5% in the MSCI World Index. At the end of August this year, that had grown to 66.7%.

This illustrates just how dominant the US market has been over this period. Over the past five years, returns from the MSCI USA Index have been 14.67% per annum. The MSCI World Index has returned 11.0% per annum over the same time.

The bulk of the return from global equities has therefore come from the US market.

There are however concerns around the extent to which this has been driven by multiple expansion and not underlying growth in earnings. The MSCI USA Index is now trading on a price-to-earnings (PE) ratio of 29.6 times. The Nasdaq 100 is on a PE multiple of 36.4 times.

Some global equity managers, growing wary of how much longer this can be sustained, are therefore turning their attention to Europe. There is a feeling that there is a rotation starting to happen out of richly-priced US stocks into European equities offering more compelling valuations.

Citywire asked three local top-performing boutique managers running global equity funds to give their views on this phenomenon and how they are positioning themselves at the moment. They were unequivocal in their agreement.

Click through the slides to read their views.

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At the start of 2014, US-listed stocks had a weighting of 54.5% in the MSCI World Index. At the end of August this year, that had grown to 66.7%.

This illustrates just how dominant the US market has been over this period. Over the past five years, returns from the MSCI USA Index have been 14.67% per annum. The MSCI World Index has returned 11.0% per annum over the same time.

The bulk of the return from global equities has therefore come from the US market.

There are however concerns around the extent to which this has been driven by multiple expansion and not underlying growth in earnings. The MSCI USA Index is now trading on a price-to-earnings (PE) ratio of 29.6 times. The Nasdaq 100 is on a PE multiple of 36.4 times.

Some global equity managers, growing wary of how much longer this can be sustained, are therefore turning their attention to Europe. There is a feeling that there is a rotation starting to happen out of richly-priced US stocks into European equities offering more compelling valuations.

Citywire asked three local top-performing boutique managers running global equity funds to give their views on this phenomenon and how they are positioning themselves at the moment. They were unequivocal in their agreement.

Click through the slides to read their views.

Citywire A-rated Richard Pitt, CFA

CEO at BlueAlpha Investment Management and manager of the BlueAlpha BCI Global Equity fund

 

There are signs of a possible rotation out of US equities into selected European equities in global markets. How do you currently view these two opportunity sets?

There has been much talk of a possible rotation out of the US and into ‘value’ regions like Europe and Japan – particularly in the context of any risk-on turnaround post-Covid. In turn, we’ve received numerous queries related to positioning, as the BlueAlpha BCI Global Equity Fund has been relatively heavily weighted toward the US (+-80% exposure to US-based companies).

We don’t necessarily view the US or Europe as two separate opportunity sets. Rather, we seek out companies with high returns that are able to grow. Over time, these are the businesses that are meaningfully able to compound returns for investors.

We also expect to pay up for these returns, as it’s rare that you’ll encounter a great business with outstanding long-term prospects that’s cheap. With this philosophy in mind, many companies that meet these criteria are listed in the US.

That’s not to say that there aren’t any European or Asian businesses that fit this profile – Tencent and Alibaba are great businesses that earn most of their revenues from China – it’s just that these types of operations are more frequently large global businesses with strong market share that happen to be US-based.

Given the reach of companies like Apple or Amazon, their exposure to both developed and developing markets allows them to take advantage of strong returns, regardless of regional biases. Some examples from the portfolio include Mastercard, which earns only 32% of its revenue from the US; Domino’s Pizza, which operates in 90 markets, and so the fact that it was founded in the US is just legacy; and PayPal, which generates 47% of revenue outside of the US.

Given the impacts of the pandemic and the responses of both governments and central banks, liquidity is at all-time highs and inflation is still some way off. In this context, blue-chip businesses with strong market share and growth opportunities seem to be the only option for investors.

Furthermore, plunging discount rates mean that businesses that are able to generate strong cash flows, are seeing the value of those cash flows increase substantially. With this in mind, it also explains why tech companies are almost single-handedly driving markets higher. This is an industry which generally has high returns on capital as well as good growth – they generate a lot of cash. Covid-19 has also mostly enhanced the growth of many Tech companies by fast-tracking the behavioural tailwinds which were already in their favour.

With all of these points in mind, we see the best opportunities in businesses with a strong global reach, that are able to sustain high returns, and fuel growth with the cash that they generate. The majority of these types of opportunities are often in the tech space, or employing tech to their benefit. We will continue to seek out companies that present the best possible opportunities for investors – wherever they’re listed.

 

Francois Roux

Co-manager of the Autus Prime Global Equity feeder fund

 

There are signs of a possible rotation out of US equities into selected European equities in global markets. How do you currently view these two opportunity sets?

Talk of a rotation from US to European equities tends to be motivated by two factors: valuations and geographic diversification.

Much has recently been written about increasing concentration in the US stock market. The five largest companies now account for over 20% of the market capitalisation of the S&P 500. It is tempting to draw parallels between now and the height of the tech bubble of the late 1990’s, when a similar level of concentration of the top five companies was recorded.

One aspect that is often neglected when making this argument is that the earnings contribution from the top five is currently only slightly below 20% of the total market. This implies that the valuations of the top five are not completely dislocated from their earnings power. This observation is in stark contrast to the situation two decades ago, when the earnings of the top tech companies were minuscule compared to their valuations.

The second point is that neither the large US companies nor the large European firms are as exposed to their home markets as intuition would suggest. For example, among the top five US technology stocks (Apple, Microsoft, Facebook, Amazon, and Alphabet) only Amazon earns more than half of its revenue from the US (around 70%). The other four earn less than half of their profits from their home market and the rest from its international markets.

The situation is similar in the large European stocks. Nestlé, Roche, and Novartis are Swiss companies with the vast majority of their revenue originating from markets outside of Europe. Taiwan, with its burgeoning chip manufacturing industry, is the largest market for Dutch behemoth ASML while SAP is a German software company with operations in over 180 countries.

As such, investing in a particular geography does not necessarily translate into much exposure to that geography, especially among large capitalisation stocks.

Investors would be better off focusing their efforts on the merits of a particular global stock or investment strategy, as opposed to rotating between geographies based on weak assertions.

Citywire A-rated Nick Dennis

Manager of the Anchor BCI Global Equity feeder fund

 

There are signs of a possible rotation out of US equities into selected European equities in global markets. How do you currently view these two opportunity sets?

I am focused on finding and holding ‘multibaggers’ – companies and shares that can increase by multiples of their current size over the next five to 10 years. These companies are typically founder-led, highly innovative and sell useful products in large markets.

The US leads the multibagger race by a distance, with China coming in second and Europe a mere speck on the horizon. This could be a function of Europe’s inherently socialist and risk-averse culture, as well its smaller, heterogeneous markets. While there are a handful of interesting European companies, the pickings are relatively slim compared to the US and China.

Headline ‘cheapness’ of the major European indices versus the US is misleading, reflecting differing sector compositions (more banks and materials, less tech) rather than any fundamental mis-pricing. Best-in-class, fast-growing European companies are just as expensive as their US peers, if not more so.

A bet on Europe outperforming the US likely depends on a reflationary environment, with persistently rising growth and inflation. This would be conducive for traditional value and cyclical stocks, favouring Europe due its sector tilts.

That said, while factor timing (value vs growth, high vs low beta etc.) is alluring in theory, it is all but impossible in practice. In any event, given structural dynamics globally, such a move would probably be short lived.

Covid-19 has accelerated several trends which were in place before the pandemic hit, including the adoption of technology by businesses and consumers, and the widening gap between the market’s winners and losers. Europe is on the wrong side of these trends. Until Europe starts creating its own Amazon, Microsoft and Netflix et al, en masse, it’s hard to see it outperforming the US on a secular basis.

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Related Fund Managers

Richard Pitt
Richard Pitt Average Total Return:
66.82%
23/96 in Equity - Global (Performance over 3 years)
Francois Roux
Francois Roux Average Total Return:
4.47%
50/127 in Equity - Global (Performance over 3 months)
Nick Dennis
Nick Dennis Average Total Return:
110.96%
6/96 in Equity - Global (Performance over 3 years)
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