Value stocks have fallen out of favour compared to growth stocks, but as inflation rises this will change, according to Citywire AAA-rated James Sym.
Sym, who runs three funds including the Schroder ISF European Equity Focus fund, said in an investor update that quantitative easing and low bond yields meant growth stocks had outperformed their value peers.
‘There are now very few fund managers who have an overweight allocation to value stocks, examples of which are commodity-sensitive stocks, financials and industrials,’ Sym said.
‘Extreme levels are being reached, both in terms of the relative performance of growth and value and in terms of where the market is positioned. In our view, value stocks are almost as cheap as they have ever been and a reversion to the mean would offer significant double-digit upside.’
Sym added inflation would be the catalyst for investors returning to value stocks. While inflation expectations are currently low, Sym said there were signs it was picking up and said US inflation is almost back to normal.
‘Europe’s labour market is tighter than one might realise from headline unemployment figures. Certain pockets of industry are experiencing relatively high wage inflation, e.g. engineering, and there have been minimum wage increases in various countries.’
‘After 10 years of underinvestment, there is little slack in Europe’s factories so capacity utilisation is running at around average levels. Any further upturn in demand could see price increases come through,’ he added.
Sym said oil prices were unlikely to fall much further and oil stocks could benefit from a rise in inflation. Oil and gas company Royal Dutch Shell is the largest company in the fund at 5.4% and Sym holds 8.3% in the energy sector.
‘Oil companies were actually not the major gainers from the oil price boom of a few years ago because their costs rose exponentially. However, the recent oil price drop has forced companies to rein in their costs and, assuming this discipline continues, we see oil as a value sector that offers significant upside potential for investors.’
Banking on value
Another sector which could benefit from a change is financials. It is the largest sector allocation in the fund at 29.9% and banking companies make up half of the top ten holdings with ING Groep the largest of these at 4%.
‘Bank share prices in particular have come under heavy downward pressure and an end to increasingly negative interest rates would be crucial for their performance.’
‘If banks were to return to their mean average discount to the wider market, this would imply 50% outperformance from current levels,’ the manager said.
The Schroder ISF European Equity fund, which Sym took over in February of this year, returned 17.8% in euro terms over the three years to the end of April 2016. This compares to a 24.6% rise by its Citywire-assigned benchmark, the FTSE World Europe TR EUR, over the same timeframe.