Value style managers have struggled on a relative basis to keep up with broad market indices, which have been driven higher by a handful of mega-cap quality / growth companies mainly listed in the US. Value managers have been underweighting these winners and overweight shares, which have struggled on a relative basis notwithstanding the excellent value on offer vs. price, which has largely been ignored by the market.
Value managers are currently overweight cyclical businesses, which are perceived to be lower quality businesses owing to the cyclicality of their earnings. These cyclical businesses have been underperforming defensive / quality / growth businesses for a decade now since the Great Financial Crisis (GFC) and the unprecedented stimulus unleashed by global central bankers.
Defensive / Growth / Momentum style investing benefited from massive inflows as investors were prepared to pay more and more for the earnings from a narrow basket of winning companies. Many of these winners have used cheap debt to sustain earnings per share growth by buying back their own shares and maintained attractive dividends payments funded from debt with no or little actual earnings growth backing up their dividend policy.
The proliferation of passive / quantitative investment vehicles, which now exceed assets under active management in the US has exacerbated the demand for these overpriced businesses as most passives investments are determined by market capitalization (share price X shares in issue) and thus price agnostic i.e. continuing to buy already expensive shares as they go up further in price. The dispersion between expensive companies and cheap companies is in the 99th percentile, which is the widest gap the market has ever experienced, and this was prior to the Corona price collapse, which has seen this gap stretch even further.
What has previously happened in similar pricing cycles is a massive reversion / rotation from expensive to cheap with value investing re-established as the most sensible strategy to build wealth over the long-term and why value has outperformed growth over the last 90 years, but just not the last 10 years.
And then Came Covid-19…….
The world went crazy as politicians shut-off their respective economies forcing the global economy into a recession. What did investors do, they panicked and sold everything and bought the US 10yr. treasury bonds and defensive quality / growth shares notwithstanding the already stretched valuations of these businesses.
The shares, which sold off the most were the cyclical businesses held by the value managers, which intuitively feels right if the world is heading into a recession and these businesses are most exposed to the economic cycle. But what the herd has continued to ignore is price, cheap got even cheaper with many businesses now trading at levels, which seem to indicate bankruptcy and although there may well be some businesses that do go bankrupt, the majority will survive.
Value investors need to stand back from the herd and try being patient a little longer in the knowledge that prices do matter even in a world dominated by Modern Monetary Theory or the acronym MMT, which could just as easily stand for Magic Money Tree….
Mcomm, CFP®, HdipTax
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