This year has been a difficult one for Value stocks. In the last few weeks Value stocks declined for 14 consecutive days, the longest losing streak in history. https://x.com/Barchart/status/1869861064050921753

Growth stocks ($VUG) have beaten Value stocks ($VTV) by 20 percentage points this year. The underperformance of Value has been particularly severe in the last month. https://x.com/SoberLook/status/1868979935869857947

This has also affected the portfolio, which now shows little outperformance over the index in 2024.

This year European stocks have returned +2%, Asian stocks +1%. Of 45 countries tradable as ETFs, 2 have outperformed the portfolio. In the US, where Growth stocks returned +35%, value stocks returned +16%. It has been a challenging time for value investors everywhere, and particularly for those investing outside the US. seekingalpha.com/etfs-and-funds/etf-tables/countries

It is starting to feel like investors are becoming a little too optimistic about stocks, and especially the US market, which is why I have added some defensive exposure (Utilities) to the portfolio.

Optimism can be seen in US vs Europe stock valuations and positioning:
https://x.com/TaviCosta/status/1870937369215631367
https://x.com/ReturnsJourney/status/1868405393434787974
https://x.com/Schuldensuehner/status/1869067239833694688

and low cash levels https://x.com/MRBullMktEver/status/1869434224073384429

both of which reflect the strong US economy.

Economic strength in the US, and fears about Trump’s tariffs, have led to higher US interest rates. This has hurt the Real Estate positions in the portfolio, so I’ve been looking into the risk of even higher interest rates to assess how a position in Real Estate might go wrong and if so, by how much.

The starting position is that from a longer-term valuation perspective, interest rates look about fair right now. advisors.vanguard.com/content/dam/fas/pdfs/ISGVEMO.pdf

There is no major inflation problem in the US, UK or euro area. This can be seen in indicators such as PMI output prices, M2 money growth, commodity prices and forward-looking wage indicators. www.pmi.spglobal.com/Public/Home/PressRelease/8537676804634a8b9243c2911f2243a1www.longtermtrends.net/m2-money-supply-vs-inflation/www.ecb.europa.eu/press/blog/date/2024/html/ecb.blog20241218~1b3de009b4.en.html

As a result it seems unlikely that absent tariffs or other shocks, interest rates would need to increase much.

This would reduce the pressure on real estate valuations. Valuations have already adjusted to the current level of interest rates, and have stabilised or are starting to increase.
www.cbre.com/insights/briefs/impact-of-interest-rate-cuts-on-real-estate-cap-rates

Yet, investors must be worried about a second leg higher in interest rates, because many European real estate companies can be bought at a 30% discount to Net Asset Value (NAV).

This is a good deal should interest rates stay at current levels or even decline.

The risk is that Trump’s tariffs or political pressure on the Fed cause interest rates to go up. This risk is in part mitigated by the portfolio not having any US real estate exposure. But the risk can’t be totally eliminated, because all global interest rates are affected by US rates to some extent.

A 30% discount to NAV affords protection – a margin of safety – against value declines brought about by higher rates.

Overall, I find that Real Estate valuations are fair relative to interest rates. There is a risk of higher rates in 2025 due to politics, but the stocks already discount some of it. Real Estate companies fundamentally return 8-10% a year through dividends and rent growth. If valuation discounts narrow, returns can be more. The current discounts appear excessive relative to inflation risks in Europe.

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