06 Jun 2022
We are repeatedly being asked whether the current value rally is a blip or the long-awaited comeback. The answer is of course “we don’t know”. Any true value investor, unlike our growth cousins, is always wary of pretending to know very much about the future. But given we keep getting asked the question we probably should at least try to answer it.
We believe there are a number of good reasons why a return to value has failed over the last decade or so, but this is no longer looking to be the case, in our view.
Firstly, market participants have held deeply embedded and self-reinforcing trend favouring growth/quality stocks. And the longer that has gone on, the more energy is required to knock Mr Market off course.
Any attempts at a return to value have also been pretty feeble – they have not lasted long and not been particularly large. So, it has been relatively easy to ignore them; in fact, we learned over the last decade that any value rally was a brilliant chance to double up on growth. Indeed, any attempt to place valuation boundaries on your stock picking has been most unwise.
But one factor to consider is that it is not the case this time – the rotation to value has been both violent and prolonged. Growth investors are nursing very significant losses, particularly those who came in late to the party, but in many cases those who came in pre-covid have also suffered.
Secondly, we think it is important to remember the starting point for this rotation. This shift to value has followed the incredible growth/quality rally that happened in the post-Covid world. (To us this looked a lot like a “blow-off top”/capitulation phase which is reasonably common at the end of long-run trends).
This pushed valuation dispersion within the market into new territory – on many measures, readings were in the 100th percentile for as far back as most commentators could find the data (so quite possibly the widest in stock market history).
For someone who started this job in February 1999 and witnessed that absolutely crazy year, I would never have believed things could ever get crazier than that….and then they did almost exactly 20 years later. The importance of this is we think the extremeness of the starting point should mathematically materially increase the chances of this rotation continuing. Particularly because of the next reason…..
Our third reason for optimism about value’s potential is that we think a number of powerful long-running trends which proved a headwind for value in the past are not only coming to an end, but are almost certainly reversing (we discussed this development in our June 2020 blog ‘2020s – the decade of the ‘cheap asset’).
The last decade or so has been characterised by increasing globalisation, ever declining interest rates, central bank dominance, large scale credit creation, unbelievable money printing and deflation. We feel these factors were very strong drivers of extreme valuation dispersion and, dare we say it, speculative excess.
However, it is becoming increasingly clear that in the next 10 years the world is going to be very different. If the world is going to change, we think very different stocks are going to do well and do badly.
This point is something we think is very much overlooked when thinking about the potential for future outperformance. In my experience, most people think of value stocks and growth stocks as two separate, but fixed, groups of stocks. The reality is they are not.
As regimes change, a number of stocks which used to be value become the new ‘darling’ growth stocks – think of those really boring consumer staples stocks during the TMT (technology, media and telecom) boom which were then feted during the ‘bond proxy’ love-in of the mid-to-late 2010s.
Conversely, a number of those growth stocks become the new value stocks – think of telecommunications stocks pre- and post-the TMT bubble, or bank stocks pre- and post-the financial crisis.
We believe this will happen again here. If we are right, and you see companies moving “buckets” from these starting valuation spreads, the potential outperformance of value is momentous, in our view.
Our fourth observation about value’s potential is that the markets are still very long growth, and very short value. Our brief analysis of various databases shows almost all the funds under management in mutual funds are not in value styles. We have not done the work on retail trading databases, but we think it is self-evident that growth stocks are more than fairly represented there.
And while we have seen some (courageous?) clients allocating money to our M&G Value funds, the reality is the majority of market participants are really not willing to shake their belief in growth investing just yet and we have not seen much of a switch take place.
Despite this caution, our answer to the question about whether this could be the start of a sustained value rally is yes, we do think it is different this time for value. The potential for value to do very well from here is enormous, in our view. But don’t believe us, as dedicated value investors, we are the least objective people in the world to be asking that question to.
And one more thing. We also get asked a bit if this is now a good opportunity to pick up some cheap growth stocks? That might be the subject for another post, but the short answer, in our view, is “not even close”.
By Richard Halle
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.