“Blessed are the meek: for they shall inherit the Earth.”
Matthew 5:5
On 9th November 2020, the world changed for the better. An effective
vaccine against covid-19 was announced. It was also the day that stock
markets experienced the largest intraday market reversal of price momentum
ever recorded. November went on to be a record-breaking month for
European equities (+15%). It was also a record for “value” (low price to
book) versus “growth”, and the 25 worst performing stocks up to 9th
November outperformed by 30-35% over the month. However, the reversal
looks somewhat less impressive in a longer-term context. So, the question
confronting investors is whether they face a tiny ripple against the long-term
flow or more of a sea change.
Marathon’s European portfolios have not been so exposed to the “value” versus
“growth” divergence found elsewhere in the world, largely due to the fact that
Europe does not have a large, highly valued technology sector. Indeed, Europe’s
largest technology stock has been SAP which accounts for less than 2% of
the index, and the stock has declined by 20% over the last 12 months due to a
recent large profit warning. The sector is only 7.3% of the overall benchmark.
Marathon’s capital cycle approach in Europe has favoured quality businesses
in recent years due partly to the damaging effect of zero interest rates and low
growth on the traditional value sectors. Financials and Energy have been the
standout negative performers, falling by 30.7% and 49.3% respectively in the
year to 30th October. Financials have suffered from negligible interest margins
and fears of an escalation in bad debts, whilst Energy has had to contend with
the green revolution and the collapse in the oil price, at least partly induced by the pandemic. These two sectors combined had shrunk to less than 20% of the
European benchmark by the end of October.
This, together with significant chunks of the consumer discretionary sector,
exposed in some form or other to the effects of the pandemic (hospitality, travel,
leisure, etc.), has meant that investors have had to focus on safety and resilience
– those stocks whose businesses will survive the pandemic and will emerge,
ultimately, unscathed at some unknown point in the future.
The effect of this environment has been to exacerbate further the strains on
“value” sectors that had already been built up by years of declining interest rates
(the result of an extended period of QE) and low economic growth. This process
was further impacted by the slowdown of China and the effects of the trade
wars. Political risks (US elections and Brexit) have intensified the uncertainty –
and then there was the pandemic. In such an environment, it was the safe and
secure bond proxies which flourished and the Schumpeterian process of creative
destruction appeared to be suspended. Marathon’s capital cycle approach was
compromised by zero interest rates as companies didn’t go bankrupt and largescale M&A was taken off the menu. Now, this looks to be changing. Nowhere
more so than in the “value” arena, where our exposure has been significantly
raised since the vaccine news appeared. We have moved from being 10% below
the Financials sector weight at its 25% peak in 2008 to just 2.5% underweight
at its new nadir of 15.7% today. Whilst in Energy we were 5% below the index
weight at its peak of 13% in 2009 to now be only 0.5% underweight a sector
that is now only 4.5% of the index. The prospects for these sectors now look
much more attractive as the starvation of investment has led to a more attractive
competitive profile.
The Energy sector has been trading at record low multiples as the effects of the
pandemic on transportation, alongside the growing green agenda, meant that
the stocks have been regarded as pariahs. Throw in an OPEC dispute and it was
understandable why the sector languished. Now, however, transport demand
is set to recover, the oil price has regained 75% of its YTD losses, companies
such as BP have pledged to be carbon neutral by 2050, and indeed the sector
is, ironically, the largest investor in renewable energy! Healthy dividends should
return promptly. In the meantime, the sector has slashed capex which is down
more than 50% from the 2014 peak and investment is standing at a ten-year low.
Returns on capital should only improve from here. Likewise, in the oil services
sector, the CEO of Saipem talked recently of improving trends.
In Financials the situation is perhaps more nuanced. Dividends had been banned
for 2020 but now small payouts are being permitted by the authorities in the
UK and this guidance is likely to be adopted in Europe. Banks have, however,
conserved capital and this has enabled them to strengthen balance sheets in the
face of a bad debt crisis that does not appear to be materialising. There has also
been a silver lining from record low interest rates in that fintech challengers have
found it almost impossible to fund themselves through deposit gathering – yet
their customer acquisition costs, not to mention technology investment, has
to be covered. Indeed, the loan book of the most successful fintech in the UK,
Starling Bank, is almost all effectively government guaranteed. The major banks
admit they are now less concerned by fintech challengers.
That the current “value” rotation has started and will accelerate in the first
half of 2021 has quickly become a consensus view amongst the major equity
strategists. There are many triggers; the current recovery from pandemic-induced
record GDP falls, the likely concomitant pick up in interest rates, if not long bond
yields, the ongoing stimulus by authorities who need costly unemployment to
fall, the excessive valuations of bond proxies (L’Oréal being a prime example)
and tech stocks (with the latter beginning to experience a regulatory backlash)
and perhaps, most importantly, the weight of money that is in the wrong part of
the market and has to move. In the first ten months of 2020, the majority of EU
funds outperformed, suggesting a strong quality bias. The reversal was savage in
November as the funds that are in liquid index backing ETFs, growth ETFs, etc.,
will have had to start shifting. This weight of money effect is likely to continue to
tilt the balance in equity markets for some time to come.
Legal Notices & Disclosures
Performance data shown represents past performance and is no guarantee of future results.
All charts and data are for illustrative purposes only. Views expressed herein are those of Marathon Asset
Management, LLP and may not be reflective of their current opinions or future actions, are subject to change
without prior notice, and should not be considered investment advice.
The information provided in this presentation is for informational purposes only. The information provided in this
article should not be considered as a recommendation to purchase or sell a particular security. The weightings,
holdings, industries, sectors, and countries mentioned may change at any time and may not represent current or
future investments.
The MSCI All Country World Ex. US (ND) Index is a free float-adjusted market capitalization weighted index that is
designed to measure equity market performance in the global developed and emerging markets, excluding the U.S.
This unmanaged index does not reflect fees and expenses and is not available for direct investment.
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fund before investing. To obtain a summary prospectus or prospectus for this and other information, visit
harborfunds.com or call 800-422-1050. Read it carefully before investing.
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*Redistributed with Marathon permission
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