Market Updates

European ETFs inflow remains muted

Published On: April 29th, 2021|By |Categories: Market Updates, Value|7 min read|

The first quarter earnings reports have started positively. With only 10% of companies having reported so far, the table below shows that both sales and earnings expectations have increased over the last couple weeks. Positive earnings revisions are consistent with a recovering global economy and imperative given the stretched valuations of most equity indices.

S&P 500 1st quarter earnings scorecard

That equity analysts expect this positive earnings momentum to continue for some time may been seen in them raising not only their near-term forecasts, but also increasing their 2021 and 2022 full-year numbers (chart below).

S&P 500 Annual Consensus EPS Estimate
SUBTLE ROTATIONS THAT BEAR WATCHING

While equity market performance remains broadly positive, there are some subtle rotations occurring under the surface that bear watching. The performance of prominent Growth stocks has picked up over the last few weeks, having underperformed Value by a wide margin since November of last year. Of particular interest, is that this Growth advance has not been as broad and inclusive as the previous climb higher. The chart below shows that investors have only bid the large-cap Growth stocks higher (mainly technology) but continue to exit the smaller Growth stocks. An advance based on narrow participation is a classic signal of the end stages of any rally.

Russel 1000 growth vs. Russel 2000 growth

We monitor several macro variables to better understand the evolving levels of market risk present at any time. Our current read of those variables is that the biggest hurdle the market faces is lofty expectations and crowded positioning (right tail problem), as opposed to a more sinister surprise (left tail problem). We have been cutting back on those positions we view as most valuation vulnerable while our investment style tends to protect us from entering overcrowded positions.

INVESTORS (STILL) REMAIN IN US MARKET DESPITE ITS LOFTY VALUATION

On both these measures, European equities continue to look very attractive. As we have highlighted, European equities have broken out from an extended period of underperformance and poor absolute returns. However, as the graph below shows, this breakout has been met with little fanfare as most investors remain enamored with the growth prospects of the U.S. market despite its lofty valuation. Investor inflows into European focused ETFs remain muted.

Europe Equity ETF flows | Eurostoxx 600

We expect this investor indifference will reverse as confidence grows in the sustainability of the European earnings recovery which is set to surpass that of the U.S. this year. The valuation gap between the U.S. and Europe remains at multi-year lows (graph below) and offers high attractive risk/return investment opportunities.

MSCI Europe NTM P/E Relative
A LARGE PERCENTAGE OF INVESTOR INFLOWS IS ESG FOCUSED

One segment of the market that has certainly attracted a disproportionate percentage of investor inflows is ESG (Environment, Social & Governance) focused investing. No fundamental long-term investor can ignore ESG considerations in their research of a company and we certainly support the much-needed attention this brand of investing is placing on important issues that go beyond a company’s short-term financial performance. That said, our guard is always raised when we observe trends charterised by indiscriminate investor inflows into a limited investable universe. This inevitably leads to unsustainable overvaluation and consequent disappointment over realized investor returns. We can already observe a substantial valuation rerating among ESG darlings that cannot be attributed just to changes in the longer-term company prospects. ESG investing, as with any segment of investing, requires a solid valuation framework if it is to prove a sustainable investment movement and not merely another fleeting investment fad.

ESG ETF AUM vs. All Equity ETF AUM

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ABOUT THE AUTHOR
David Williams (1970) is verantwoordelijk voor het beleggingsbeleid van Mpartners. Na een korte carrière bij het Ministerie van Buitenlandse zaken van Barbados begon David in 1997 bij Insinger de Beaufort Asset Management en in 2002 werd hij director. Hier droeg hij verantwoordelijkheid voor het investment team en de beleggingsfondsen (zowel long-only als gehedgde portefeuilles). Zijn specialisatie is Europese aandelen. In 2010 heeft hij samen met de andere partners Mpartners opgericht. David Williams heeft een B.A (Honors) van de University of Kent, een M.Sc. in Internationale Politieke Economie van de London School of Economics en een MBA van Nijenrode.