The relative strength in European equity indices must be taken with a large pinch of salt.

On both 15 and 16/05, we marvelled about the extreme concentration of market performance on a handful of very large stocks : Nestlé, Novartis, Roche. LVMH, Hermes, Kering, l’Oréal.

Moving on and selecting the 17 largest market caps in the AlphaValue coverage, it became very obvious (see following chart) that the money was on liquid mega caps in some sort of a self-feeding loop, presumably magnified by ETF. Interestingly, the relative performance accelerated over the last few days.

Since early 2018, mega caps have outperformed by 17%


Clearly as fund managers cannot have 10% or more of their portfolio in a Nestlé which gained 27% (!) ytd, the only option is to buy into an ETF that will have an even bigger Nestle exposure. Buying into that ETF merely adds to the upward pressure on Nestle. This 17 stocks universe will pay a handsome 3.5% yield but only under the condition that one wants to own HSBC and three oil giants. Without these, the prospective yield falls to 2.9% still good to have but with a 1.74 PEG, i.e. it is important that this universe’s modest earnings growth (8%) does not disappoint.

If markets are pushed up by liquidity corners, why not explore the next layer of market caps (between €50bn and €91bn)? That makes for another 24 stocks combined into the following relative performance chart: +8% or so over the last year (or half that of the first group).

Relative outperformance of €50-90bn market caps

This second group offers a 3.9% dividend yield and will trade at a 1.3x PEG. It is clearly less overbought. Should the liquidity push continue, one could dream and see that group gain another … 33% to match the demanding valuations of their even bigger siblings.

We currently only see a 10% upside potential for this 24 stocks universe and certainly have only a minimum understanding of how ultra-low rates can percolate into equity values. For the record, the default Wacc at AlphaValue is 8.5%. Take away 100bp and the sky is the limit, obviously.