Rate testing
Beyond the US, it is hard to say when interest rates will start going up. The big developed countries are all at different stages of their economic recoveries, with the US now leading leading the way, the UK next and Europe bringing up the rear. Interestingly, all the major developed countries and regions exhibit the same pattern with regard to the relative performance of value and growth, as can be seen in the chart opposite.
Janet Yellen would seemingly rather live with higher inflation than be forever known as the Fed chair who caused an unnecessary recession by raising rates early.
I suspect value factor indices will continue to underperform growth factor indices for a while longer – in the US, the UK, Europe and Japan. But, I am optimistic global growth will, in the not too distant future, reach escape velocity, driven by a pick-up in emerging economies as well as continued recovery in consumer and business confidence in developed economies.
The length and nature of any recovery tends to be commensurate with the severity of the slump that preceded it. This, however, does not mean a value-oriented investor cannot do well. Value investing should be about finding stocks whose yields are higher than you think they should be.
This means they do not have to have low valuations in absolute terms but relative terms, and thus allow one to consider more ‘growthy’ opportunities.
Such a view of value investing allows us to incorporate two other factors that have persistently outperformed over the long term: quality and size. In fact, our key value metric is dividend yield, which, although it is a component of the various value factors, is also for many index providers a factor in its own right.
As with value, there are various explanations as to why higher quality companies – as defined by stronger balance sheets and better profitability – and smaller companies have outperformed. Investors generally fail to appreciate fully the scope for small companies to get bigger, not just in the near term but also the long term.
As for quality, I would guess stronger balance sheets are associated with lower growth. In reality, the opposite is the case.
Although value investing is associated with equities, it is based on the principal of buying things cheaply. This is a principal that is not only sound but also can be applied to other areas such as bonds and even asset allocation.
In the case of bonds, we are looking for those with real yields that are higher than we think they should be and avoiding those that are lower. A good example of the latter would be the 30-year index linked Gilt – if you buy it today and hold it to maturity you are guaranteed to lose 20% of your real capital. In the case of asset allocation, we are looking for markets where yields are higher than we think they should be. This has drawn us towards European equities as well as alternative investments such as asset leasing vehicles and renewable energy infrastructure funds.
What were the two stocks that fell into both value and growth camps? AXA and Daimler. It will be interesting to see how they perform over the next few years.
