Value managers have been seen to be “throwing in the towel” but investors are eyeing up the prospect of a rotation away from growth as valuations become even further detached from reality and governments pledge billions of pounds in fiscal stimulus.
During a recent webinar hosted by Columbia Threadneedle, the firm’s head of UK equities Richard Colwell (pictured) posed the question: “Has QE made us all growth managers?”
More than a decade of ultra-low interest rates and monetary easing measures from central banks has made any companies offering significant growth above the norm look even more attractive, says Willis Owen head of personal investing Adrian Lowcock.
Prices of so-called ‘quality growth’ companies versus optically cheap value stocks have become further detached since the Covid outbreak. The performance gap between the S&P 500 Growth and S&P 500 Value indices is the largest it’s been in 25 years.
JP Morgan Asset Management global market strategist Mike Bell notes that during the global financial crisis in 2009 the MSCI Growth index was trading on a P/E of 11x earnings. Today he says the index’s P/E ratio is closer 30x earnings.
“These valuations for growth stocks are not normal during a recession, certainly not during a recession as deep as this one,” says Bell.
Tech and ‘fashionable’ stocks take off while value favourites stall
Paul Green of BMO Gam’s multi-manager team notes “fashionable stocks” are trading at sky high valuations. Zoom which was valued at $14bn at IPO last year is now valued at $70bn and is on a P/E of 1400x, he notes, while 10,000 day traders an hour are buying shares in Tesla.
Money has been flooding into dedicated tech funds like Polar Global Technology, which soft closed last month, after attracting £1.6bn inflows over three months.
See also: Outperforming tech still attractive as funds rake in £5bn from coronavirus rally
Against this backdrop Green says there is a sense that traditional value managers, who have been unloved for over a decade, have had enough.
“We’re seeing signs of investors throwing in the towel,” Green adds, “whether that’s through style drift, ie those managers who used to call themselves value that have now loosened their process in buying growth stocks and are now more core in nature, or whether it’s managers such as Mark Barnett leaving Invesco, and Alastair Mundy of Ninety One temporarily stepping back.”
Right before the crisis Portfolio Adviser found several funds traditionally billed as “value,” including the Henry Dixon and Jack Barrat-led Man GLG Undervalued Assets fund, had been exhibiting more growth–like characteristics.
Risks in growth stocks could be just as big
While quality growth investors have come out on top of value managers once again during the coronavirus crisis, Colwell says this “does not in any way mitigate the idea that all value is dead”.
In such an extremely polarised market he thinks having a portfolio of optically cheap stocks for the sake of it is as dangerous as only owning quality growth stocks that are doing well at the moment. “To be stylised so extreme one way or the other I think would be very risky.”
“Having too large a bias towards growth or value could be very dangerous,” Lowcock agrees.
“Investors have seen this year what having too much in value stocks will have done to their portfolios as the companies in this space fell hard and languished after the rest of the market rallied.
“The irony is that the risks in growth stocks could be just as big, but the perception is very different as growth companies have been performing with some share prices having risen at astonishing rates,” he adds.
Rapid growth in online retail looks unsustainable
Covid has dramatically accelerated the pre-existing structural trends of businesses migrating online and the adoption of cloud technology, says Bell.
Software, tech hardware and online advertising are among the S&P 500 sectors that have enjoyed the biggest boost, up 28%, 25% and 14% respectively year-to-date, while traditional value sectors like airlines (-52%), hotels (-51%) and energy (-41%) are in the doldrums.
“The big trade that’s gone on has been buy the stocks which are less exposed to Covid, sell the stocks which are more exposed,” Bell says. “But what that has done is created a situation where valuations, at least for some stocks in some sectors, have got pretty stretched.”
One area he thinks the market is currently making big assumptions about is online retail.
Online retailers in the S&P 500 are up 60% year-to-date while American-listed department stores are down 60%. The sector is currently trading on a forward price-to-earnings of 68x with 2021 earnings for the sector forecast to be 29% higher than 2019 which Bell notes is “pretty punchy”.
“I think that online share of retail spending will still be higher than it was pre-Covid,” he says. “But will it be as high as it is now once we have a vaccine and will it just continue to keep growing at a rapid pace, which is what’s being priced in? That seems less clear.”
Is a value rotation possible?
Both Colwell and Green think a regime change could happen if the economic situation improves and inflation picks up.
Colwell says the effects from central banks loose monetary policy combined with ramped up fiscal spending from governments could trigger higher inflation which means some of the initial “winners” during the crisis could come under pressure.
Some growth businesses may be able to absorb rising input rates but he says the de-rating which tends to coincide with sustained inflation can drastically stunt shareholder returns for years like in the case of the Nifty Fifty.
Green says governments have already begun spending and are unlikely to pull back until they see established economic growth.
Reduced capacity at restaurants and pubs and other shops to maintain social distancing measures and protect margins over a prolonged period could also help push prices up, he says.
“It’s not 100% guaranteed that’s going to happen, and the timing of it it’s very unclear,” he says. “At the moment everything is priced for low growth, low inflation, low rates into perpetuity and our view is it won’t take much of a pick up in growth inflation expectations to see a potential rotation out some of the more expensive growth names into value.”
Style regime change unlikely until a vaccine is found
Bell agrees that higher fiscal spending in infrastructure, like Boris Johnson’s proposed £5bn ‘New Deal’, would boost commodity prices, which historically have been one of the key determinants of value outperformance.
But he doesn’t think a value style rotation is likely to happen until the virus is contained. “The most clear catalyst for value outperforming is a vaccine or a scenario where somehow the virus becomes under control without a vaccine,” he says.
In order for airlines, department stores, energy companies and banks to outperform “you need to have confidence that people can go back to flying, they can go back to using hotels, they can go back to shopping and the oil price is going to go higher, that people are going to be able to afford to pay their mortgages and their loans so that bank share prices can rally.”
At the moment he thinks the most sensible strategy investors can take is to be neutral equities with a focus on quality companies and “a strong valuation overlay”.
BMO Gam’s multi-manager team prefers a balance of both growth and value managers as a rule of thumb. “I think to make a wholesale shift from growth to value, it’s very hard for investors to do because that would mean you’re selling good performing funds and buying poor performing funds,” Green says. “That’s psychologically quite hard to do.”
The team is currently overweight UK due to its relative cheapness and underweight US equities which continue to look expensive. For its UK value play Green says the multi-manager team is holding Hugh Sergeant’s River & Mercantile UK Recovery fund, as well as Dixon’s Man GLG Undervalued Assets and Artemis UK Select, which is co-managed by Ambrose Faulks and Ed Legget. He highlights Sergeant in particular for his strong track record coming out of crises, noting his £174m fund’s pickup in performance during the global financial crisis and European debt crisis in 2011.
