- Investors stung by extreme volatility went on the defensive
- Cash still king, with global allocation highest since 2008
In a quarter when European equities saw the most volatility in three years and the worst returns in four, investors did something that might seem strange: they bought high.
Companies with the loftiest valuations, a group that includes stable profit generators such as Roche Holding AG and L’Oreal SA, beat a basket of cheap stocks by the most on record in the period, data compiled by Morgan Stanley and Bloomberg show. It happened as a gauge of price swings jumped 34 percent above its three-year average and shares fell 11 percent through yesterday. They regained 2.5 percent on Wednesday.
Signs that the slowdown in China is spreading just as the Federal Reserve prepares to raise interest rates are leading investors to shun anything with a hint of risk. Slower global growth projections, tumbling commodity prices and lower estimates for corporate profits have erased gains in the Stoxx Europe 600 Index that at one point swelled to 21 percent for the year. That put a premium on safety -- a quality that is perceived with higher-priced stocks, according to Yves Maillot, head of European equities investment at Natixis Asset Management in Paris.
“The global economy has disappointed -- that was a very bad surprise for many investors and they went on the defensive,” said Maillot. His firm manages 329 billion euros ($370 billion). “In this context, you want to own stocks with better visibility, positive free cash flow and less volatile business models, instead of playing the deep cyclical companies.”
Dragged lower by a plunge in commodity producers and automakers, the Morgan Stanley cheap-stock index, including BMW AG and Statoil ASA, has slumped 18 percent this quarter, sending its valuation to an average of 13.1 times estimated profits of its members. That compares with a 6.5 percent decline in the gauge tracking the most expensive shares, which trades at 19.9. The Stoxx 600’s valuation is at 14.7, down from a record high of 17.4 in April.
The Stoxx 600 closed at the lowest level since January on Tuesday, leaving it within 2 percentage points of a bear market. The gauge, which started the quarter with its biggest monthly rally since February, ended with all but one of its industry groups down. Carmakers and mining stocks plunged more than 25 percent.
Falling stock prices propelled a measure of euro-area equity volatility to its highest levels since 2012. At the same time, analysts lowered their 2015 profit growth estimates for Stoxx 600 companies to 4.8 percent, from 6.5 percent at the end of June.
After the selloff made cheap companies even cheaper relative to the so-called higher quality stocks, diverging valuations now offer more options for fund managers who focus on finding value, according to Dirk Thiels at KBC Asset Management. He said his firm has a preference for consumer stocks.
“There is very definitely value in Europe at this point,” said Thiels, who helps oversee 204 billion euros as KBC’s head of investment management in Brussels. His firm went neutral on equities last month from an underweight allocation. “Concerns about China are very real, but it should be much less important than the market is discounting for Europe’s cheaper stocks. Timing is crucial in such volatile markets.”
Even with almost all European stocks trading at lower valuations than earlier this year, investors worldwide trimmed their stock holdings as cash piles rose to levels last seen in 2008, according to a Bank of America Corp. fund-manager survey this month.
The selling, which was even more pronounced for cyclical stocks, will soon flag up opportunities too cheap to miss, says Tom Stubbe Olsen at European Value Partners in Zurich.
“You see prices going down for companies you believe in,” said Olsen, manager of a $1.5 billion fund that invests in companies deemed undervalued. He has outperformed the market this quarter, and he said he has started to buy more equities. “As value investors, you try to be patient -- the only choice we have is to make volatility our friend and make the most of the valuation disparities. People are very nervous.”