“Value” is a term which gets thrown around like a rag doll. Of late, it has been afforded about as much respect; as its performance has been chewed over, mauled, and left as an unappetising mess in the corner. Battered and forlorn, it is an increasingly overlooked investment style. Growth, its investment twin, is the only one who gets invited to the ball ideally in clothes made of sustainable cotton and driven there in a zero emission Tesla. Value, meanwhile gets left behind to get on with some dusting, like Cinderella in her attic.
What has gone wrong? As you can see in the following graph, Growth has trounced Value ever since that fateful day in August 2007 when the world engine began to splutter and shudder with ever increasing frequency, as the sub-prime grit in its innards coursed through its pipework.
To start with, a few definitions will come in handy. A “Value” investing style has quite some pedigree. Benjamin Graham and his much more famous disciple, Warren Buffet are the sages who are the founders of this investment creed. Several generations of investors have picked over the “Sage of Omaha’s” every utterance for decades, often going on a yearly pilgrimage to listen and fuss over the significance of Warren’s every inflection of voice, cough and word at his company’s AGM in Omaha, Nebraska. Up to 40,000 investors make that trip most years. For the incurably star-struck, bus tours are organised to go and see their investment guru’s favourite local restaurant to eat the same choice of burger and coke. So what do you learn when you get there? You learn about the importance of caution, the importance of going against the grain and of the uses of the long-term view. You learn the importance of cashflow and of preferring simple businesses run by plain-speaking management you can trust.
It’s common-sensical and it uses the warps of our human psychology to its advantage. For markets are above all emotional, with fear of loss and greed for gain being powerful forces pushing prices over the short-term. For if no-one has a bad word to say about the stocks you own, it feels safe, the price will be high and the fall all the more painful if your stocks ever lose their lustre. On the other hand, if you own stocks to which people turn up their noses, it will be overlooked and cheap. If it fulfills people’s low opinion, then it should not fall much, and should it get its act together, it can rapidly increase in price as people climb aboard.
What of “Growth”? Here investors vie to spot an up-coming trend and buy before that potential is fulfilled. In the absence of crystal balls, it is not easy and can lead to a lot of dangerous “crowding” into the latest fad. It is of what bubbles are made. But done well, it can be highly successful, for it plays in to another human kink. Given the future is by definition unknowable, on occasion we tend to step too cautiously, often failing to spot the future forests in the stock acorns before us. Those who are good at finding these can make impressive returns.
So which style is best? Well, turning to the gushing quote fountain that is Warren Buffet “Growth and Value are joined at the hip”. Today’s stock value is highly dependent on tomorrow’s growth. Sifting stocks into two tidy piles called “Growth” and “Value” has always been a spurious exercise. At best, it is just short-hand for the level of caution or optimism which investors bring to their forecasting skills. Yet sifting stocks into these two piles has become market convention. Once piled up, you can pour them into an index and see how they perform against each other. As can be seen in the graph above, the last 12 years have all been to the advantage of Growth.
The next question is then what is the best way to explain such a surge? Such outperformance needs its two legs to propel it forward. The first is the extraordinary rise of the FAANGs, the acronym for the world’s largest and most successful tech stocks (Facebook, Apple, Amazon, Netflix, Google). Combined, these five companies – four of which did not even exist at the start of my investment career – now have a collective market cap just shy of that of Japan’s GDP. Many of these have benefited from the internet age’s propensity to create dominant oligopolies with much lower capital requirements than in the past. They are the rulers of “Capitalism without Capital”. Stripping these five companies out of a Growth index accounts for 60% of its outperformance since the start of the global financial crisis. The second leg pushing this outperformance forward is the lack of inflation in the system.
When inflation is high, it is easier to grow simply by upping your prices. When inflation has gone missing, you have to sweat all the harder for your growth. Only the best can do this and scarcity can only be bought at a high price. If investors believe you can grow your business for many years into the future in spite of low growth, then in a world where you get peanuts for leaving your money at the bank, you will be much loved. Your stock will have a stiff following wind pushing it upwards. If we look at the MSCI US Growth Index since inception 46 years ago, overall it has a tendency to outperform when inflation is low and underperform when it is higher. That is exactly what you would expect.
What could change this happy picture for Growth investors? You have to have the patience of something as inert as a stone to endure waiting for Quantitative Easing (QE) to produce inflation. Over ten years on, it has not happened and maybe never will. Under QE, central banks create electronic money out of thin air to buy assets, mainly government debt held by banks. This keeps demand for government debt high and interest rates low. It also oils the world’s financial plumbing to avoid any crisis but, so far, it is not creating any inflation. However, there is a new acronym in town which could pack more of an inflationary punch.
MMT stands in for Modern Monetary Theory and is as “Modern” as coin clipping and other means of debasing the value of gold and silver coins in centuries past. Here the central bank creates electronic money out of thin air so that government can spend it on things like bridges, trains and hospitals. Clearly, if you can get money this way, you don’t have to collect quite so much tax. You cannot only invest in infrastructure but cut voters’ tax bills. Now that definitely does have the prospect of raising prices. When a government or individual gets given an unexpected bonus, a good part of that will be spent, putting pressure on the price of all sorts of things like cement, groceries and holidays.
Unsurprisingly, this idea has caught the eye of politicians. When you can spend on infrastructure, cut people’s taxes and create a bit of inflation to erode the value of your own debt, then there is a lot to like. Branded “People’s QE” by Jeremy Corbyn, it has a potentially much more important sponsor in Christine Lagarde, the new President of the European Central Bank (ECB). She has brought forward a review of the ECB’s interest rate policy from the end of the year to this summer. Rumours are that MMT could be brought in cloaked in green clothing; central bank money being created for the purpose of investing in the needed transition to a “net zero” carbon economy by 2050. It may well be good for the planet, but it will also be good for inflation.
When that happens the Value Cinderellas will be done with dusting their dingy garrets and their time to sparkle will have come around again.
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CLI01575 Expiry 28/02/2021