Strategy Matters Europe Why the risk premium could unlock so much value

Transcription

January 7, 2013
Europe
Strategy Matters
Portfolio Strategy Research
Why the risk premium could unlock so much value
For a long time we have highlighted the long-term valuation opportunity we see in equities
reflected in the high ERP and other valuation metrics. However, increased uncertainty and the
higher ERP are also key to explaining a range of relationships in the market. A lower ERP would
unlock a significant number of alpha opportunities in the market and substantially change the
leading themes and investment styles. We show why. We also roll-on our 3- and 6-month index
targets and we close our long Stable Growers (GSSTGRTH) recommendation.
The ERP and the macro market
Peter Oppenheimer
Increased uncertainty has led to increased correlations. We show that there
is a close relationship between the ERP and correlations of stocks within
the market and also across asset classes. A lower ERP would reduce
correlations, increase alpha opportunities and also enhance the value of
active management and long/short strategies.
+44(20)7552-5782 peter.oppenheimer@gs.com
Goldman Sachs International
The ERP and growth and closing our long Stable Growers call
Gerald Moser
The high ERP has reduced the value of duration. Investors have been less
willing to pay for growth further into the future as the future has become
more uncertain. This leaves growth undervalued. In general, investors
have been willing to pay more than normal on a relative basis for top-line
growth and stability of growth than for margins or earnings. A lower ERP
would increase the premium paid for cyclical growth as the last few weeks
has demonstrated; the premium paid for stability would tend to fade.
Sharon Bell, CFA
+44(20)7552-1341 sharon.bell@gs.com
+44(20)7774-5725 gerald.moser@gs.com
Christian Mueller-Glissmann, CFA
+44(20)7774-1714 christian.muellerglissmann@gs.com
Anders Nielsen
+44(20)7552-3000 anders.e.nielsen@gs.com
The ERP and the financial crisis
There has been a strong relationship between the ERP and relative bank
stocks performance, as well as the P/B of banks. The ERP has also moved
closely with sovereign debt spreads. We would expect a lower ERP to be
associated with a reversal of these trends and to unlock value in financials.
Matthieu Walterspiler
+44(20)7552-3403 matthieu.walterspiler@gs.com
The ERP and use of cash
There has been a close relationship between the ERP and the ratio of cash
to assets on corporate balance sheets. High uncertainty has encouraged
corporates to hoard cash. As the ERP fades, we would expect more
buybacks, increased investment, and M&A.
Roll-on our index targets
We roll-on our 3- and 6-month SXXP targets to 290 and 295 (from 280 and
290). Our 12-month target is unchanged at 310, implying 8% upside.
Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors
should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors
should consider this report as only a single factor in making their investment decision. For Reg AC certification and other
important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by
non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.
The Goldman Sachs Group, Inc.
Goldman Sachs Global Economics, Commodities and Strategy Research
January 7, 2013
Europe
Why the risk premium could unlock so much value
We have continued to highlight the importance of valuation as a driver of long-term returns. We
believe the European markets, in particular, offer attractive value as growth expectations built into the
market have collapsed. However, equities in general remain attractive relative to other asset classes,
particularly bonds. This was the main thrust of our argument in The Long Good Buy; the Case for
Equities (published March 21, 2012) wherein we highlighted the very high required equity risk
premium. We see this as both a reflection of uncertainty and an indicator of the high potential returns
available in equities over the medium term.
The equity risk premium – as a measure of uncertainty – is important for markets in many ways. It not
only provides a guide to future long-term returns, it is also the key to explaining a number of critical
relationships in the market and the pattern of relative returns that have dominated the market
environment over the past five years. In our view, a slow but steady fall in the required ERP over time
should unlock a number of important opportunities within the equity market.
In this piece, we want to highlight some of these key relationships and demonstrate the themes that
we believe could change if the risk premium falls over time.
Relationship 1: The ERP and the macro market
The importance of macro factors as a driver of returns across and within asset classes has risen
substantially in recent years. Investors often talk of the existence of a ‘macro’ market; one in which
returns are driven by the influence of economic or political outcomes rather than companyidiosyncratic drivers. The so called ‘risk on / risk off’ swings that have characterized market conditions
over recent years can also largely be explained by changes in perception about the risks or outcomes
to a series macro factors or political/policy outcomes. We can see this effect by looking at the
relationship between the implied equity risk premium (derived from our four-stage discount model GS
DDM) and the correlation of stocks within the market. As Exhibit 1 shows, when uncertainty is high
and rising, most stocks move together in the same direction as they are affected by the same macro
factors. The last couple of years have illustrated this relationship very clearly. The focus on Greece, or
European banks, for example, has had a significant impact across all stocks (but by varying degrees
depending on beta) as they often move sharply together in one direction or another. These
relationships were described in detail in Correlation dislocation; drivers and implications, Global
Strategy Paper no 5 (published June 28, 2012).
Exhibit 1: STOXX Europe 600 12-month correlation vs. European ERP (%)
STOXX Europe 600 12-month average pair-wise stock correlations
0.55
STOXX Europe 600 12-month correlation
European ERP (RHS, %)
0.50
10
8
0.45
0.40
6
0.35
4
0.30
0.25
2
0.20
0
0.15
0.10
-2
90
92
94
96
98
00
02
04
06
08
10
12
Source: Datastream, Goldman Sachs Global ECS Research.
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January 7, 2013
Europe
The tendency for correlations to rise as the risk premium goes up has been true not only within
equities but also across asset classes. Higher cross-asset and cross-equity correlations have also
impacted investment performance and styles. As Exhibit 2 shows, higher correlations are also related
to lower performance of long/short equity funds relative to the broader index. The recent fall in
correlations has coincided with an improvement in hedge fund performance.
Exhibit 2: Hedge fund performance is influenced by the degree of stock correlations
12m performance of equity hedge funds & 12-month average pair-wise stock correlations
60%
0.10
50%
0.15
40%
0.20
30%
0.25
20%
0.30
10%
0.35
0%
0.40
-10%
0.45
HFR Equity hedge fund
-20%
0.50
STOXX Europe 600 correlation (RHS, inverted)
-30%
90
92
94
96
98
00
02
04
0.55
06
08
10
Source: HFR, Bloomberg, Goldman Sachs Global ECS Research.
Equity long/short funds tend to be stock pickers and often focus on pair trading and relative value
within sectors and countries. Based on hedge fund performance indices from HFR, equity hedge funds
tend to struggle when equity correlations are high (and higher risk premia) as alpha opportunities fade.
Implications: As the ERP decreases, we expect common macro factors to tend to become
less of a market driver. Stock correlations would tend to fall and alpha opportunities
should rise. This should play into the hands of active management strategies relative to
passive strategies.
Theme 2: ERP and growth
This theme has been central to the way that we have looked at the equity market over the past three
years. Our argument has been that, as uncertainty rises to ever-higher levels, the willingness to pay for
cash flows further into the future decreases. In other words, the value of duration falls.
Certainly, the willingness to pay for earnings growth has been fading. As Exhibit 3 shows, the average
forward PE for stocks of companies in higher bands of expected earnings growth has faded relative to
the average over recent years.
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January 7, 2013
Europe
Exhibit 3: The slope of the ‘growth’ curve remains relatively flat
Consensus year-3 sales estimates for the STOXX Europe 600
20
12m Fwd P/E
18
Current
Long term average
Dec-11
16
14
12
10
'Valuation gap'
8
6
< -10%
-10% - 0%
0% - 5%
5% - 10% 10% - 15% 15% - 20% 20% - 30%
> 30%
Earnings growth bands
Source: Datastream, I/B/E/S, Goldman Sachs Global ECS Research.
But we find that not all growth is seen as equally valuable. Indeed, it is sales growth that has become
particularly scarce. This is also where the ERP comes in. We find that, as the ERP rises,
companies with the highest expected sales growth are valued more highly than those with
the highest expected earnings growth (Exhibit 4). We believe this reflects the more
predictable nature of top-line growth in some sectors that are less economically sensitive.
It is also because earnings are also dependent on margins, which investors tend to be less
confident about, particularly given the uncertainty of the economic cycle.
Exhibit 4: Relative P/E of high sales growth vs. high EPS growth stocks is related to ERP
Consensus year-3 sales growth estimates for the STOXX Europe 600
1.4
11
P/E high sales vs. high earnings growth
1.3
9
Pan Europe ERP (RHS)
1.2
7
1.1
1.0
5
0.9
3
0.8
1
0.7
-1
0.6
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
Source: Datastream, I/B/E/S, Goldman Sachs Global ECS Research.
Greater uncertainty has also increased the premium for stability or predictability. This is why we have
recommended our ‘stable’ growers’ basket (GSSTGRTH)– a sector-neutral basket of companies that
have a long track record of achieving top-quartile earnings growth, sales growth and ROE with low
volatility of growth. As Exhibit 5 shows, the relative performance of this basket has moved closely with
the rising ERP over recent years.
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Europe
Exhibit 5: Stable growing companies (GSSTGRTH) outperform with a higher ERP
Relative performance of our Stable Growers basket
160
9.5
150
8.5
7.5
140
6.5
130
5.5
120
4.5
110
3.5
100
GSSTGRTH vs SXXP
90
Jan-06
2.5
Implied ERP (RHS)
1.5
Oct-06
Jul-07
Apr-08
Jan-09
Oct-09
Jul-10
Apr-11
Jan-12
Oct-12
Source: Bloomberg, Goldman Sachs Global ECS Research.
The desire to find stability of growth and higher quality is also reflected in other relationships. Our
sector analysts recommend a strategy that favours the stocks of companies that generate a high cash
return on cash invested (CROCI). Over time, our back-testing has indicated that a strategy of favouring
first-quartile (Q1) returns versus fourth-quartile (Q4) returns has paid off well in terms of superior
performance. However, this strategy not only performs well over time, but investors are prepared to
pay relatively more to implement this strategy in a very uncertain macro environment. As Exhibit 6
shows, the higher the ERP, the higher the relative EV/GCI of companies that exhibit superior CROCI.
Exhibit 6: The valuation premium of companies with superior CROCI increases with higher
ERP
Based on our analyst coverage
4.0
Implied ERP (%)
12
Relative EV/GCI of 1Q CROCI vs. 4Q CROCI companies (RHS)
3.5
10
8
3.0
6
2.5
4
2.0
2
1.5
0
-2
1.0
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
Source: Datastream, Goldman Sachs Global ECS Research, Goldman Sachs Research estimates.
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Europe
High and stable returns are also a function of relative competitive strength. Our sector analysts rank all
companies that they follow by ‘industry positioning’. Our back-testing has also indicated that this, too,
has been a winning strategy over time, and demonstrates particular value in periods when the
required risk premium rises.
The risk premium is also connected to the performance of cyclicals versus defensives, especially over
short periods as we have witnessed in the last couple of months. Over the longer term, there is not a
strong structural relationship between shifts in the ERP and the relative performance of cyclicals. Since
2000, the ERP has risen from about zero to 8% and yet cyclicals performed roughly in-line with
defensives over this period (with swings in between of course) – see Exhibit 7.
Exhibit 7: European cyclicals vs. defensives performance with the level of the ERP
Cyclicals: media, general retailers, travel, leisure goods, chemicals, basic resources, construction
& materials, industrial goods & services, autos & parts.
Defensives: food & beverages, tobacco, health care, food & drug retail, utilities.
110
-2
Cyclicals vs Defensives
100
Implied ERP(RHS, Inverse)
0
90
80
2
70
4
60
50
6
40
8
30
20
10
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
But this does not mean that the risk premium has no impact. We find that the changes in the risk
premium (i.e. the short-term moves) can have a significant influence (Exhibit 8).
Exhibit 8: European cyclicals vs. defensives performance with the change in the ERP
50%
40%
Cyclicals vs Defensives % YoY Change
ERP falling
YoY Change in Implied ERP (RHS, Inverse)
30%
-4
-3
-2
20%
-1
10%
0
0%
1
-10%
2
-20%
3
-30%
-40%
4
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
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Europe
Implications: As macro uncertainty rises sharply, investors tend to migrate to quality –
higher-returning, cash-generative, well-positioned companies that have stable top-line
growth. While we believe that these are stocks that are likely to outperform over the long run (even in
less risk-averse conditions), the premium in valuations paid for these stocks may well moderate as the
risk premium gradually fades. Put another way, a lower risk premium would tend to result in a
relative re-rating of the stocks of companies with superior through-cycle earnings growth.
Many of these are likely to be in more cyclical sectors as opposed to economically insensitive
sectors.
Given this, we close our long recommendation on our Stable Growers basket (GSSTGRTH).
Since we initiated the recommendation on September 28, 2012 the basket has underperformed the
SXXP by 3.5% (total returns). The stocks in this basket are selected on the basis of their high and stable
sales and earnings growth and ROE. As shown above, these stocks have been favoured in recent years
(and we have previously held long recommendations on this group) as we believed they offered
investors both relative ‘safety’ and the potential for growth in a ‘growth-less’ world. But, if over the
medium term the risk premium does continue to fall and as global growth improves, there is less of a
compelling case for being long these names, in our view.
Theme 3: The ERP and the financial crisis
Of course, the onset of the financial crisis was one of the key drivers to the higher risk premium. While
the ERP had already adjusted upwards before the start of the financial crisis – driven by the significant
de-rating of equities after the technology boom of the 1990s – it was the collapse of the US housing
market that really triggered the rise in uncertainty. No sector has been more implicated and associated
with the current crisis than the financials sector. For that reason it is, perhaps, unsurprising that the
relationship between the ERP and the relative performance of the banks sector has been very high.
Each time the ERP has fallen, the banks sector has rallied – obviously there is some reverse causality
here too; rallies in the banks sector and sovereign spreads have also reduced the required risk
premium as tail risks have been seen to moderate.
Exhibit 9: There is a strong relationship between the relative performance of the banks
sector and the implied ERP …
Banks SX7P vs. SXXP relative performance indexed to 100 in Jan-07.
140
130
-0.5
Banks vs SXXP Relative Performance
Implied ERP (RHS, Inverted)
0.5
120
1.5
110
2.5
100
3.5
90
4.5
80
5.5
70
6.5
60
7.5
50
8.5
40
Jan-07
9.5
Sep-07
May-08
Jan-09
Sep-09
May-10
Jan-11
Sep-11
May-12
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Europe
Exhibit 10: … as well as between the valuation of the banks sector and the implied ERP
Banks SX7P P/B has moved with the risk premium
2.5
-1
1
2
3
1.5
5
1
7
0.5
9
Banks NTM PB
Implied ERP (RHS, Inverted)
0
11
04
05
06
07
08
09
10
11
12
Of course, the relative performance of banks stocks has also been closely aligned to European
sovereign spreads. The inextricable link between sovereign yields and banks stocks has meant the
fortunes of the two have been closely linked. The ERP has also correlated closely with sovereign
spreads.
Exhibit 11: Peripheral sovereign spreads have closely correlated with ERP
11
6
Average Spanish and Italian minus German 10-year bond yield
5
10
Implied ERP (RHS, %)
9
4
8
7
3
6
2
5
1
0
Jan-08
4
3
Sep-08
May-09
Jan-10
Sep-10
May-11
Jan-12
Sep-12
As investors moved out of peripheral Euro-area markets, they moved into perceived safer indices. This
is best illustrated through the SMI, which has had a close relationship with the ERP. A rise in the risk
premium in recent years has seen strong performance by the Swiss index, and also a flow of money
into Swiss francs.
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Europe
Exhibit 12: The Swiss market has risen vs. the SXXP in lock-step with the ERP
In euros
240
10
SMI vs Stoxx600
ERP (RHS)
220
8
200
6
180
4
160
2
140
0
120
-2
00
02
04
06
08
10
12
Implications: We expect a fall in the ERP to be associated with narrower sovereign spreads
and better performance in the banks sector.
Theme 4: ERP and corporate use of cash
The level of the risk premium has been important not only in explaining the patterns of performance
within the market, but also the behavior of the corporate sector. As Exhibit 13 shows, there has been a
close relationship between the ERP and the ratio of cash to assets on balance sheets. In effect, greater
uncertainty and poorer macro clarity have encouraged companies to hoard cash, even while the return
on cash has fallen to negative in real terms. In the case of European corporates in particular, the added
uncertainty about access to funding given the deleveraging of banks may have also played a part. If
the ERP were to moderate over time, we believe that corporates may start to use cash in a more
proactive way. This could be either into investment spending, M&A, or even buying back shares (and
boosting ROE) given that the cost of equity is so high relative to the cost of debt. There has been a
viscous cycle between uncertainty and hoarding cash which, in turn, has reduced growth expectations
further. This has made equities more ‘bond-like’, forcing their yields higher to compensate for lower
growth. If uncertainty reduced, corporates may use cash more proactively either to buy back stocks
(and boost ROE) or to invest. This, in turn, could improve long-term growth expectations and
effectively lengthen the duration of the market, reducing the ERP yet further.
Implications: A lower ERP could boost corporate use of cash to enhance investment or
ROE via share buy backs.
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Europe
Exhibit 13: The reluctance of companies to commit cash to investment, buybacks, or M&A
is a function of the high ERP
Ratio of cash to assets for the Euro-area non-financial corporate sector
12.5
9
12.0
8
11.5
7
6
11.0
5
10.5
4
10.0
3
9.5
2
Cash/Assets (%)
9.0
Market Implied ERP (RHS, %)
1
8.5
0
-1
8.0
99
00
01
02
03
04
05
06
07
08
09
10
11
12
Source: ECB, Datastream, Goldman Sachs Global ECS Research.
Roll-on our index targets
We make some modest changes to our near-term targets for the key European markets.
These changes we view as rolling-on our three- and six-month targets to reflect the passage of
time since we published Euro Vision – finding growth in stagnation (November 28, 2012) and to reflect
the resolutions to avert the ‘fiscal cliff’ in the US – removing one source of uncertainty. Our 12-month
forecast of 310 for the SXXP is unchanged and from current levels implies 8% price return over 12
months and an 11% total return. We also revise our FTSE 100 and Euro STOXX 50 targets (Exhibit 14).
We have a relatively shallow profile of returns over the next three and six months. This partly reflects
the potential we see for a pause after such a strong rally in stock markets, but also acknowledges the
weak profile for GDP growth in both the US and Europe in 1H 2013. We expect growth to improve
through the year and for global GDP growth in 2014 to be 4.1%; given this, we continue to expect
strong equity performance for the year as a whole.
Exhibit 14: Index targets: Modest upward revisions over 3 and 6 months
European Indices Forecasts
Stoxx 600
Price level
3 months
6 months
12 months
New
290
295
310
FTSE 100
Old
280
290
310
New
6100
6200
6500
Old
5900
6100
6500
EURO STOXX 50
New
2750
2800
3000
Old
2650
2800
3000
Source: Goldman Sachs Global ECS Research estimates.
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Equity baskets disclosure
The Securities Division of the firm may have been consulted as to the various components of the baskets of securities
discussed in this report prior to their launch; however, none of this research, the conclusions expressed herein, nor the
timing of this report was shared with the Securities Division.
Note: The ability to trade this basket will depend upon market conditions, including liquidity and borrowing constraints
at the time of trade.
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Disclosure Appendix
Reg AC
We, Peter Oppenheimer, Sharon Bell, CFA, Gerald Moser, Christian Mueller-Glissmann, CFA, Anders Nielsen and Matthieu Walterspiler, hereby
certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their
securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views
expressed in this report.
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13
January 7, 2013
Europe
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14

Strategy Matters Europe Why the risk premium could unlock so much value

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