07 Oct 2020
Here’s a headline that won’t surprise you: the gap between growth and value stocks is now at its highest since the dotcom boom.
Data from Empirical Research shows that there have only been two other occasions since 1926 when the relationship between growth and value has been so stretched: once in the early 1930s and then in 2008-9.
Some argue that the pandemic will exacerbate this gap. For example, earnings in the second quarter showed what we already knew: that tech companies have benefited from an acceleration in the adoption of home-based activities. At the same time, some companies that were already struggling to arrest structural pressures, such as physical retail, have seen their problems increase. Of course, the economic cycle will be yet another factor. But the historical relationship between the economy and growth or value stocks has changed.
There are nuances within the value-growth labels. ’Defensive growth good, cyclical value bad’ is a refrain currently doing the rounds. This begins to identify some of the variances within ‘value’, which is generally perceived to perform well as the economic cycle improves. But from the perspective of an active manager, this is an over-simplification. Yes, a number of lowly-valued companies can be found in sectors which are more economically sensitive. But our managers can also find many companies offering reasonable or cheap valuations in more defensive parts of the market, such as telecoms or utilities.
It’s also worth looking at the changing anatomy of value stocks. In 2000, healthcare stocks were only 6% of the value index. Today, they have more than doubled. It is difficult to see immediately how pharmaceutical stocks with multiples in the mid-teens fit into today’s global value indices.
Source: MSCI as at 30 June 2020
This leads to the important distinction of what a value investor does. The factor-driven description of value is defined by MSCI as price versus book value, cashflow and forward earnings. These are key inputs for any investor. But value investing entails a great deal more investigation to identify companies with attributes that are under-appreciated – and therefore undervalued.
Each potential holding is assessed on its inherent prospects: the company’s management and culture; its potential for growth versus its peers (easily overlooked if stocks are bucketed by the sector they’re in); the stability of cashflow in different economic environments; and many other qualitative inputs which come from face-to-face meetings and first-hand research.
Our fund managers have a range of different investment approaches from absolute return through thematic to growth at a reasonable price. None of them are pre-determined ‘value’ managers and none is given to dogma about growth versus value. Each team assesses each stock on its individual merits to build portfolios. Taken at face value, this may end up with what looks like a bias towards value – and a selection of our managers have built and had to defend notable positions in ‘value’ stocks. But for many of our managers and the funds that they manage, this will be transitory exposure to this style characteristic.
Equally, it doesn’t mean that our fund managers sell a stock because of a fixation on value or a narrow definition of what value means – or, more accurately, used to mean. Some are comfortable holding stocks such as Amazon and will continue to do so. Others who have profited from the tech rally are now considering a rotation to cyclicals because their prices are relatively attractive. A value play? Not in simple terms.
But are we in the weeds here? Are we focusing too much on a fundamentals-based argument when central banks have distorted the market? If price discovery was more difficult in the past decade because of quantitative easing, what about now with even vaster support from central banks? Low interest rates have in some cases distorted discounted cashflow models and made growth companies more attractive. The ‘whatever it takes’ scale of interventions by central banks have arguably stopped a potential rotation away from richly-valued stocks. And the yield curve is being kept flat for the foreseeable future, which neuters the argument that a rising yield curve would imply economic growth and so a more favourable environment for value stocks.
It’s important to separate correlations from causality. Some value stocks will have a closer correlation to bond yields and the economic cycle, with financials and commodities two obvious examples. But data going back over 100 years shows value strategies delivering strong performance across different environments. Even looking back to the post-dotcom environment – in which there was recession; steep cuts in interest rates; the revelation of large-scale fraud; and the invasion of Iraq – value stocks entered into a substantial rally.
It’s also important to separate value stocks from the valuation-driven ethos of most fund managers. Our fund managers will continue to seek out stocks with attractive valuations and potential growth. A number of these will happen to fall in the ‘value’ categorisation. But each will have been selected on the company’s individual merits and prospects. The many nuances within value and growth mean that there are ample opportunities to grow both dividends and earnings – and to potentially satisfy ‘growth’ and ‘value’ investors alike.
To find out more about Artemis Fund Managers visit the website at www.artemisfunds.com.
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Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness.
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