The shrug that greeted Nvidia’s 122% rise in second quarter revenues may suggest a change in market mood. Investors appear to be tiring of the ‘growth’ trade that has dominated global stockmarkets over the past decade. But if the great growth period is over in financial markets, is a rotation to value stocks inevitable?
The financial market and economic circumstances have been uniquely favourable to a handful of global technology companies.
Sheridan Adnans, head of fund selection at Tillit, pointed out that lower interest rates made borrowing cheaper, fuelling the expansion of high-growth companies. The future earnings of growth stocks appeared more attractive when discounted at lower interest rates.
This coincided with a rapid increase in technological innovation and digital transformation, which has helped create new market leaders and reshape industries, such as electric and driverless cars, smartphones and chatting with robots.
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Adnans added: “This further diminished the relative attractiveness of typical value sectors, like industrials, energy and financials with investor sentiment shifting away from value stocks, reinforcing their underperformance.”
Jean-Yves Chereau, multi-asset income manager at J Stern & Co, said markets have now reached a consolidation point. The technology names had started to wobble even before the recent weakness for Nvidia. His view is that this is markets acknowledging that there are cheaper sources of growth: “Markets had reached a valuation ceiling.”
John Husselbee, head of the multi-asset team at Liontrust, agreed. He said: “Investors have been nervous about calling (the rise in technology stocks) a bubble, but they don’t need to take this risk to get growth. There is good growth at cheaper prices elsewhere.”
He said that while he would be circumspect about calling a turning point, the last time US markets showed this level of concentration, it was in 1929, just before a decade of market weakness. While there is an economic story for AI, he added, the market story may be over for the time being.
But if it is a turning point, will it be a straight swap from growth to value?
Here, the picture is more complex. For a start, value has already been outperforming outside the US. In the UK, for example, value has outperformed growth over the past three years – the MSCI UK Value index has delivered an annualised return of 12.5% versus 10.6% for the broader UK index over the past three years. It is a similar picture in Europe, with the MSCI Europe Value index up an annualised 5.9% over three years, compared to 4.3% for the MSCI Europe. This is largely attributable to the strength of energy companies in the wake of the Ukraine crisis.
Adnans said an improving economic environment has helped, with value firms traditionally faring better in an upturn. He also pointed to monetary policy: “Higher rates tend to enhance the appeal of value stocks. Inflation also tends to favour value stocks, especially sectors like energy, materials and financials which are better positioned to navigate high-inflation environments. Market volatility has also been generally supportive of value stocks.”
See also: Have rate cut expectations already gone too far?
Most economists believe that inflation is likely to remain volatile, and structurally higher. Husselbee said 3.5-4% seems like a reasonable ‘new normal’. This should continue to favour value stocks, even if interest rates have seen marginal falls, which could create volatility in some typically ‘value’ parts of the market, such as banks.
It is also worth noting that ‘value’ looks different in different markets. For example, the nature of value stocks has changed in the UK. Chereau said: “It got so cheap because of its own idiosyncratic issues.”
Alex Wright, portfolio manager of Fidelity Special Situations fund, agreed: “We not only continue to find overlooked companies with good upside potential across industries and the market-cap spectrum, but we also do not have to compromise on quality.”
He is finding that a range of areas now fit a ‘value’ mandate: “Investors have sought after structural growth so much that it has left cyclical growth looking lowly valued. We have been finding new ideas in cyclical areas such as industrials, advertising and staffing and also added back into select real estate stocks and housing related names of late, where demand appears to be stabilising and valuations remain low.
“But we have also been taking advantage of opportunities in defensives, where we have added to the likes of Reckitt Benckiser, British American Tobacco and National Grid on weakness. The outflows out of UK small-cap strategies have resulted in a handful of opportunities in prior growth darlings, such as Moonpig, Team Internet and Future.”
Denny Fish, portfolio manager on the Global Technology and Innovation Team at Janus Henderson, said that even some technology companies have been reimagined as value investments.
See also: The asset allocator diary: John Husselbee
“Over the past decade plus, the market has witnessed very consistent growth in revenues and free cashflow from large technology companies,” said Fish. “As a result, many of these companies could have been classified as value investments given the relative growth rates to expectations which resulted in significant upside to what appeared to be intrinsic value.”
In Europe it is different again. Smaller companies have seen real weakness and now trade on significantly lower price to book and price to earnings ratios to their larger cap peers. This is despite their current and potential growth trajectory. This may be where ‘value’ lies in European markets, even if they are not traditional value stocks.
Growth may have finally had its day. That may see a greater focus on valuation, but it does not necessarily mean that typical ‘value’ areas – banking, mining, energy, tobacco – will outperform. In reality, such has been the focus on the large-cap US companies, value is everywhere and can even be found in some historically ‘growth’ sectors, such as smaller companies, even technology. Markets may finally be starting to pay attention.
