On Monday, we saw additional positive news on the Covid-19 vaccine front, with Moderna’s initial data looking very promising.  This is another revolutionary MRNA vaccine, similar to Pfizer’s, which released impressive data last week. More traditionally developed vaccines are coming down the pipeline as well, and treatments such as the Eli Lilly and Regeneron antibody therapies, are brightening the outlook.  As we discussed last week, these are the ingredients for both value stocks and our portfolios to thrive.  There is absolutely massive upside in value stocks, very much unlike the overall market, which I think is quite pricey, especially in the Tech space that has been so in vogue.  Below is a fantastic article by Almost Daily Grant, that I wanted to share with you, as I think it does a nice job of summarizing just how extreme this year has been for value, and why mean reversion has such enormous potential for us over the next few years.


Monday, November 16, 2020

Trading Places

A blip on the radar, perhaps.  Last week saw a notable rotation in the U.S. stock market, with so-called value stocks enjoying a performance snap-back relative to the high-flying (and technology-heavy) “growth” contingent. The Vanguard Value ETF jumped nearly 6% over the five trading day span, while the Vanguard Growth ETF sank by 1% over the same period.

For the value tribe, there is plenty of ground to make up.  A May paper from Two Centuries Investments founder and CEO Mikhail Samonov analyzed performance data back to 1825, finding that the value factor (or a strategy of going long cheaply valued companies and short richly priced ones) tumbled 59% from its most recent peak through March.  That matches 1904 as the worst drawdown on record in that near-two century span.

Of course, a certain exogenous event figures prominently in the historic valuation divergence.  “We came into this year after the big capitulation last year thinking that value is going to come good. . . We didn’t foresee a global pandemic,” Michael Barakos, co-chief investment officer for JPMorgan Asset Management’s international equity group, told the Financial Times on Oct. 26. “That’s a pretty extreme curveball that’s been very detrimental for value and very positive for growth.”

Value’s drought is spurring capitulation in some corners. In a Friday interview with the Washington Post, AJO Partners co-founder and principal Ted Aronson explained his rationale in shuttering the $10 billion, value-oriented fund. “Even if we shot the lights out, it would take us five years to get back to showing some decent historical returns.”

On the other side of the coin, growth-focused managers have flourished thanks in large part to the handful of tech-focused mega-caps which have ascended to an historic share of the indices (Almost Daily Grant’s, October 8).  Bloomberg reports today that, among 200 equity funds benchmarked to the S&P 500, those with at least 20% of assets allocated to Facebook, Amazon, Apple, Microsoft and Alphabet have generated an average 17% year-to-date return, lapping the 2.6% advance for funds which have less than 10% of funds invested in that quintet.

The blistering run enjoyed by the high-growth tech sector has pushed price tags skyward, as the Nasdaq 100 Index currently trades at 5.05 times enterprise value to projected full-year revenues, up from less than 3 times EV-to-sales in 2016 (over that four-year period, the S&P 500’s EV-to-sales ratio rose to 3.05 from 2.31 times).  Accordingly, a September paper co-written by Research Affiliates chairman Rob Arnott found that “the valuation spread between growth and value is wider than it was at the peak of the tech bubble.” Mark Schmehl, portfolio manager at the Fidelity Canadian Growth Company Fund, summed up the zeitgeist in an interview with the Globe and Mail in late October: “Valuation, I find, is a useless tool. If you base your investment decisions on valuation, you are never going to make money.”

Some fund managers expect the recent shakeout to abate in short order, with the growth contingent set to reestablish its dominance. “Every call that we’re going to rotate away from growth and toward cyclicals has been wrong for the past eight or nine years. So, I’m not terribly worried this time,” Mitch Rubin, co-chief investment officer at RiverPark Capital Management LLC, tells Bloomberg.  Speaking of tech, Rubin reasoned that: “The strategies of using the internet for commerce or the internet for media and connectivity – we still think those businesses will thrive in an accelerated fashion and we don’t want to trade away from them.”

Last week’s hiccup aside, growth bulls are sitting pretty. But might a recent turn in conditions in the new issue market presage a wider sea-change in the growth stock regime? Citing data from Dealogic, tech site The Information reports that so far this year, more than 40% of tech sector initial public offerings slipped below their IPO price a week after trading, up from 27% two years ago.  Similarly, the proportion of new offerings trading above their IPO price after six months slipped to 53% last year from 61% in 2018.   The worm can turn on a dime, as Arnott and co. noted that value lagged growth by 4,000 basis points over the 14 years through 2000, before erasing that yawning gap in a mere 13 months.