Growth companies have been at the vanguard of global markets for over 10 years now. Some large cap firms with dependable revenue streams and high barriers to entry have been able to sustain growth since the financial crisis in part thanks to investors moving up the risk scale, leaving bonds behind.
Their defensive characteristics of stability and reinvesting profits, aiming to produce yet higher returns have been attractive in a low-yield world but this month there have been flickering signs that a value mindset could be returning to markets. So what’s really playing out here?
Price is what you pay, value is what you get
Contrarian value investors tend to seek to invest in businesses that are out of favour with the consensus. Since the crisis, this has tended to mean cyclical companies like banks, energy companies and industrials.
Out of favour can mean cheap but it takes a lot of work and savvy to distinguish which firms are cheap for a reason and which have a genuine opportunity to turn it around. For the most part though, the focus has been on big consumer staples companies, beverages and healthcare as investors have looked for a low volatility alternative to fixed income, with good growth traits.
However, earlier this month cyclicals were back in the spotlight, especially in the US, but it might be too early to call a style reversal just yet.
August’s inverted yield curve sent stocks lower on fears of recession - cyclicals were hit hardest as they tend to suffer more than defensives in times of recession. But a month on, some economists are suggesting that inversion was more a reflection of foreign investors facing negative yields buying long-dated US bonds, rather than predicting a recession.
Feeling a bit more comfortable, investors saw genuine value opportunities in cyclicals, looking for them to at least recover to where they were before fears set in.
And while we can’t rule out a market pullback down the line, it’s clear the market isn’t ready to give in and start looking en masse for those unloved opportunities yet.
So we might not have a complete style change on our hands but this brief episode gives us a good chance to remind ourselves of a few things as we continue through the longest bull market in history.
Good investing over the long-term is rarely about hitching your cart to one investment approach and leaving it be. The pros might do this but they will be very upfront that their style, be it value or growth-oriented, will almost certainly have periods of underperformance.
We can take advantage of this by diversifying our portfolios with a range of styles which can pass the baton to each other when one suddenly comes into favour. It’s not about guessing, it’s about preparation because once we’ve all realised a significant reversal in prevailing styles has happened, it’s often too late to shift your assets to follow suit.
Funds like Fidelity Global Special Situations Fund are set up to prepare for times like these. Manager Jeremy Podger looks for businesses with a dominant position in their industry, demonstrating strong growth and cash flow, as well as pricing power. However, he also seeks out companies whose true value is being underestimated by the wider market. Specifically, this means businesses able to drive up the value of their shares through delivering earnings growth in excess of market expectations.
And while some will try to predict style reversals and quickly position their portfolios, Podger is more pragmatic, saying: “I aim to combine styles in such a way that ensures both growth and value characteristics. This helps to limit overall sensitivity to economic conditions and can improve the prospects for a smoother performance throughout the cycle.”
Cyclicals: Cyclical stocks relate to companies that sell discretionary items that consumers can afford to buy more of in a booming economy and will cut back on during a recession. A cyclical stock’s price will be more affected by ups and downs in the overall economy, than a defensive stock.
Value or growth style: An investment preference for shares which are lowly-priced compared with a range of measures such as earnings, assets or dividends (value) or shares of companies where the principal attraction is earnings growth (growth).
Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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