The consumer discretionary sector exemplifies this, in our view. For example, we believe online delivery companies’ high valuations relied on a low-interest-rate environment, with little or non-existent free cash flow and overpredicted growth. Consumers will likely look to reduce their purchases amid the rising cost of living, which could impact these companies’ earnings.
Conversely, companies with strong bottom-up fundamentals (that have been largely ignored in the growth surge of the past decade) could finally be recognised with higher valuations. For example, in the industrials sector, we see some very strong European companies that could benefit from the global move to more automation for discrete and process industries. In our view, these companies have world-leading positions in automation equipment and could benefit from this structural growth driver.
Conclusion: Valuations are starting to matter again and bottom-up stock-pickers who have a deep understanding of what is driving company valuations could be well placed to identify long-term winners and losers.
Potential risks to long/short investing in Europe
Of course, there are potential risks to this opportunity set. As in recent years, we could continue to see an environment where growth stocks outperform the market, and this narrow leadership works against long/short investors looking to profit from greater dispersion in returns.
In addition, there is no guarantee that fiscal policy in European countries will target the sectors outlined above. Government priorities evolve over time and can change dramatically based on factors such as war, natural disasters and election results.