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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a managing director at Panmure Liberum
The tide might be turning for so-called value stocks in the UK and Europe after a remarkable run. In recent years, the performance of value stocks — often steadier companies trading at relatively low valuations compared with assets or earnings — has eclipsed peers with faster growth in earnings or revenues in these markets.
The MSCI Europe Value Index, for example, has outperformed the MSCI Europe Growth Index by 17 percentage points in 2025 and by 5.2 percentage points annually over the past three years.
In the UK, value stocks have outperformed by 11 percentage points in 2025 and 3.2 percentage points annually over the past three years. But I fear that this trend will come to an end in 2026.
It is probably one of the best-kept secrets in stock markets that bond yields have a larger influence on returns than corporate earnings, at least for shorter time periods like one year. Around the turn of a year, there are many articles about the price targets for the year ahead for the stock markets by different banks and asset managers. And the justification for these targets is usually driven by a view on earnings growth and company valuations.
Yet, a 1 percentage point move in government bond yields in the UK or Europe typically moves stock markets by close to 10 per cent, while a 10 percentage point increase in next year’s earnings growth only boosts stock markets by about 1 to 3 per cent.
This outsized influence of bond yields on annual stock market returns reflects the mathematics behind company valuations. The fair value of a company is the net present value of all future company profits discounted to the present day. The discount rate is driven by the long-term government bond yield plus an adequate risk premium depending on the company in question.
If a company’s profit outlook improves, this will influence the expected profit for this year, next year and maybe the year after. But the impact of an improved profit outlook dissipates quickly. Meanwhile, if government bond yields change, they influence the discount rate applied to all future profits. Thus, even a small movement in government bond yields can move markets considerably.
A case in point was 2023. After the inflation spike and central bank rate hikes of 2022, investment strategists were very bearish going into the new year because they expected a recession in the UK and Europe, which should reduce earnings growth and lead to low or even negative stock market returns. Astute investors, though, realised that inflation and government bond yields would decline materially as the inflation spike of 2022 receded. This would lift valuations and offset the decline in earnings. At the end of 2023, the Stoxx Europe was up 16.6 per cent on a total return basis including dividends, and the FTSE 350 was up 7.7 per cent. Declining bond yields had won the tug of war with declining earnings.
In 2026, we could see another year of declining government bond yields, particularly in the UK where inflation is expected to drop substantially, and the Bank of England may well cut interest rates some more. Both should lead to lower long-term Gilt yields. Also, the chancellor Rachel Reeves seems to have done enough in her Budget last year to calm bond markets.
If 10-year gilt yields drop to 4 per cent by the end of 2026 from the current 4.5 per cent, it could boost UK stock market returns by about 5 per cent in the coming year. But not all stocks are created equal. Growth stocks have more of their profits in the distant future, while a key characteristic of value stocks is that their profits grow more slowly. Thus, the balance of future profits for value stocks is closer to the present day.
If discount rates drop because gilt yields decline, the net present value of growth stocks will increase more than for value stocks. This is because the leverage effect of lower discount rates increases the farther in the future profits are. And if gilt yields drop to 4 per cent by the end of 2026, UK growth stocks could outperform UK value stocks by as much as 5 percentage points in the coming 12 months.
Across Europe, we expect to see similar trends with inflation declining, though to a lesser degree, and the economy slowing. Both should lower government bond yields, though the complicating factor is Germany’s fiscal spending spree, which increases deficits in its economy. Hence, German Bunds may experience a smaller drop in bond yields in 2026 and a correspondingly smaller shift from value to growth stock outperformance than in the UK.