Faut-il revenir à l'Europe ? - Allo La Martingale #55

Welcome to "Allô la Martingale," a live podcast discussing markets and investment. I'm Sebanon, and today we have Julien Kistrebert, Deputy CEO of Taylor Asset Management, a firm founded in the 1980s known for its tailored approach. We'll delve into market performance, investment strategies, and whether it's time to re-enter European markets. Let's start with a market overview. The S&P 500 has seen a 5% gain since January 1st, reaching an all-time high on May 1st. This translates to a potential 20% annual return, a strong performance despite initial widespread anxiety, particularly regarding inflation and monetary policy. The dominant sentiment has been the fear of missing out (FOMO), leading to rapid re-buying during market corrections. Interestingly, institutional investors were quicker to buy this time, a shift from post-COVID trends where retail investors were more active in capitalizing on dips. Two main factors are driving this market dynamic. First, the ongoing speculation around potential deals, particularly those hinted at by figures like Donald Trump, keeps the market on edge, with investors eager to jump in once uncertainties clear. Second, significant investments in AI and robust earnings reports from major tech players are fueling growth. Almost 90% of S&P 500 companies beat consensus estimates in Q1, a near-record achievement. However, this growth is highly concentrated, with Alphabet alone accounting for about 70% of the S&P 500's earnings per share (EPS) growth in the quarter. This is largely due to the strong performance of its cloud division and advancements in AI, particularly with its custom-designed TPUs, which are more energy-efficient and effective for AI tasks than Nvidia's GPUs. Alphabet's Gemini AI model has also shown impressive results in testing. This shift has repositioned Alphabet from a perceived laggard to a leader in the AI space, leveraging its massive data centers and language model capabilities. While Nvidia has performed well historically, its recent growth has slowed compared to earlier surges. The discussion then touched upon active versus passive management, particularly ETFs. While active management is often criticized for underperforming passive strategies, studies suggest that actively managed funds with a high "active share" (meaning their holdings significantly differ from the benchmark index, typically over 70%) tend to outperform ETFs. This outperformance averages around 0.7% annually, which can accumulate substantially over 10-15 years. This highlights the value of conviction-based, long-term active management over "fake" active funds that merely track an index with higher fees. Another crucial point is the risk associated with investing in broad indices like the MSCI World for European investors, primarily due to currency exposure. The dollar's strength or weakness significantly impacts returns. For instance, in the past year, US equity investors faced a 10-15% loss due to the euro's appreciation against the dollar, even if their underlying stocks performed well. Donald Trump's stated policy to devalue the dollar to boost exports suggests this currency risk is ongoing, making it a critical consideration for international investments. Turning to European markets, the Paris stock exchange (CAC 40) is down 2% year-to-date, hovering around 8000 points. Over a rolling year, it's up only 3%, far from its all-time high of 8642 reached in late February. The German DAX faces similar challenges. This raises the question: is now a good entry point for long-term investors in Europe? Several factors contribute to Europe's underperformance. For France, there's a lingering investor skepticism about the economy, partly due to perceived insufficient reforms and a persistent gap in borrowing costs compared to Germany. European stock markets, including the CAC 40, are largely held by foreign funds, making their perception crucial. Sectoral biases also play a significant role. The Paris market is heavily weighted towards discretionary consumer goods, especially luxury brands like LVMH and Hermès, which are currently facing difficulties. In contrast, markets like South Korea, with tech giants like Samsung and SK Hynix (leaders in memory chips crucial for AI), have seen substantial gains. SK Hynix, for example, has multiplied its value by eight in a year. While Europe has some semiconductor players like Soitec and ASML (a critical manufacturer of chip-making machines), they don't have the same market weight or direct exposure to the AI boom as their Asian or American counterparts. The defense sector, which saw a massive rally in late 2024 post-Ukraine war, has also cooled down. Companies like Rheinmetall, Thales, and Leonardo surged, but their valuations became very high, reflecting long-term military spending that will take years to materialize. Taylor Asset Management significantly reduced its exposure to defense stocks from 25% to 4% of its European equity funds in the summer of 2025, anticipating a normalization of valuations. This demonstrates a strategic approach to profit from thematic rallies while remaining disciplined on valuation. The discussion emphasized that while market themes can drive short-term surges, valuations eventually matter. For example, EssilorLuxottica, a French luxury eyewear company, saw its valuation multiples jump from 20x to 35x earnings due to optimism about connected glasses, only to fall back to 20x as competition and market realities set in. This highlights the importance of re-evaluating positions when valuations become excessive. Similarly, the tech sector, which traded at over 30x earnings six months ago, has corrected to 20-22x, particularly in software. Even Microsoft, despite its strong AI positioning, faces questions about the long-term impact of AI on existing software and potential disruption. The ongoing conflict in the Strait of Hormuz is another source of market stress. While it has led some American investors to repatriate capital to the US for defensive reasons, it's not considered the primary driver of European underperformance. Sectoral biases and specific company challenges (like SAP's significant weight in the DAX and its recent correction) are more impactful. Despite these challenges, Europe has champions. ASML in the Netherlands, a crucial supplier of semiconductor manufacturing equipment, is a prime example. The host highlighted that without European equipment and software, the global AI industry wouldn't exist, underscoring Europe's foundational role. Looking ahead, "electrification" is identified as a significant long-term theme for Europe. The demand for more data centers fuels electricity needs, and geopolitical events like the situation in the Strait of Hormuz reinforce the European Commission's push for energy autonomy. Companies involved in electricity infrastructure and renewable energy, like E.ON and Schneider Electric, are poised to benefit. Regarding investment timing, a common question is whether to wait until autumn to invest, given recent market highs. While timing the market is difficult, the advice is to start investing now, particularly in Europe, which is still below its historical highs. A sensible approach is to deploy a portion (e.g., one-third to one-half) of the intended investment immediately and then reassess. Waiting entirely risks missing significant rallies that could follow a resolution of current geopolitical tensions. The speaker emphasized that "there's always something" causing market uncertainty, from COVID to geopolitical conflicts, making continuous investment a better strategy than trying to time perfect entry points. For those making regular contributions (e.g., monthly from salary), dollar-cost averaging (DCA) makes sense. But for a lump sum, partial immediate investment is recommended. The AI boom, while exciting, also presents monetization challenges. While "pick-and-shovel" providers like Nvidia benefit directly from the investment frenzy, the ultimate profitability for AI developers and hyperscalers (like Google Cloud, AWS, Azure) remains uncertain. There are concerns about whether users will pay the true cost of advanced AI services and the competitive landscape, with open-source alternatives emerging. Financial instruments like Credit Default Swaps (CDS) for companies like Oracle and Corwiive, which are heavily invested in AI infrastructure, show elevated tension, indicating market skepticism about their long-term financial health. Surveys within industries like asset management reveal that AI's tangible impact on core business functions is still limited, mainly used for reporting and CRM optimization rather than direct investment strategies. Other European markets like London, Brussels, Amsterdam, Milan, and Lisbon have performed well (+5% to +13% year-to-date). This is attributed to two factors: Southern European countries are no longer seen as the "sick man of Europe" regarding debt management, with Spain, for example, actively deleveraging. Additionally, these markets often have strong sectoral biases towards financials (banks) and utilities. Banks benefit from solid interest margins, especially with a steep yield curve (long-term rates higher than short-term rates), which allows them to profit from transforming short-term deposits into long-term loans. Utilities benefit from the electrification trend. Greek banks, despite their past reputation, are now well-managed with comfortable capital ratios, offering undervalued growth opportunities. For US markets, the speaker advises caution on tech stocks, despite normalized valuations, and highlights concerns about private debt, particularly in the tech and SaaS sectors. Business Development Companies (BDCs), which are private debt funds often heavily exposed to tech companies, represent a significant, potentially systemic risk due to high leverage and the "disintermediated" nature of US finance (where loans are more often offloaded from bank balance sheets). The current shift where large tech companies now need to borrow to fund massive AI investments, rather than relying solely on treasury, signals increased financial strain. The US market's resilience, despite high gas prices and social inequalities, is explained by the concentration of consumption among wealthy individuals less impacted by fuel costs, and a "flight to safety" phenomenon where global capital flows into the US during times of uncertainty, strengthening the dollar. The US's position as a major oil and gas exporter also provides an economic buffer. Warren Buffett's Berkshire Hathaway, sitting on nearly $400 billion in cash, is seen as a smart move given current market conditions. With US Treasury rates yielding 4%, holding cash provides a decent, low-risk return, especially when equity risk premiums are unattractive. Berkshire's size, however, limits its flexibility, forcing it into large-cap investments where it's harder to find unique opportunities. Nevertheless, its underlying businesses (insurance, transport) are performing well. Investors can access Berkshire Hathaway through its Class B shares, which are more affordable than the high-priced Class A shares. Finally, Julien Kistrebert introduced Taylor Asset Management's flagship fund, "Taylor Action Entrepreneur," a small- and mid-cap European equity fund. It achieved a +50% return last year and +13% year-to-date, earning awards for its 3- and 5-year performance. The fund employs a top-down approach, identifying promising sectors and "megatrends" like electrification and infrastructure, then selecting undervalued companies within those themes across Europe. This allows them to dynamically shift allocations, as demonstrated by their exit from defense stocks and current focus on electrification and infrastructure. The fund is also Article 8 compliant under SFDR and holds the French ISR label, demonstrating commitment to sustainable investing, even while navigating complex sectors like defense (excluding anti-personnel mines). In conclusion, for the coming months, Taylor Asset Management remains cautiously optimistic, maintaining an offensive stance while adjusting portfolios. They continue to favor high-yield bonds with short durations, offering over 5% gross yield, balancing return with risk in an uncertain environment. Julien Kistrebert personally reinforced European equities during recent market dips.