European equities weakened sharply during January, falling by 4.6% in euro and by 6.9% against the strengthening US dollar. Over the quarter to the end of January, equities are up by 16.3% in euro but by only 8.2% in dollar terms.
Normally, one would expect a market setback to cause an apparent turn towards value. This generally occurs as recent outperformers and many other highly rated securities come to be seen as overextended, in the light of investors’ revised expectations and a changing perception of market risk. The market’s usual reactions then result in a relative rise in smaller value securities as the larger, more liquid, recently outperforming “growth” companies experience the largest reversals. In January, however, only part of this pattern was observable. Smaller companies outperformed, broadly by falling by less; but, in aggregate, growth stocks still look to have been the stronger performer.
A slightly deeper analysis explains how this happened and reconciles these events with our understanding of market dynamics. As a consequence of the market’s continuing interest in technology and communications, three large Euro-zone sectors (information technology, services and industrials) fared better than the rest during the recent setback. And, in these sectors, Value continued to underperform significantly during the month as investors sustained their interest in premium-rated, “high potential”, often smaller company, situations. Elsewhere, weakness did, as expected, result in a modest turn towards value.
Nonetheless, even in those sectors experiencing the sharpest setbacks, the Value upturn was particularly small. Significantly, European investors do not appear to be too “rattled” by the recent market hiccup.
Robert Schwob is director of Style Research in London.
Notes: Euro Zone includes the 11 markets within the initial formation of the euro (Germany, France, The Netherlands, Belgium, Luxembourg, Italy, Ireland, Spain, Portugal, Austria, Finland). The total sample comprises 2,800 traded securities, and returns are the cumulative market-relative total returns (including income) earned from investing in the indicated style portfolios. The analysis is presented in country adjusted and sector adjusted (using the 10 economic groups within the FTSE Actuaries Industry Classification System) format, ie, after having adjusted for industrial sector distortions and country to country distortions. Size is the primary sort, where large is the top 80% by capitalisation and small the bottom 20%. Value is taken to be the top half, by capitalisation, of each size category, sorted by book value per share to share price, and rebalanced every six months; growth is simplified as the other half within each size category.