Value is back as glamour shares fade

The market is seriously concerned about the global economy.

Value is back as glamour shares fade

The market is seriously concerned about the global economy.

Its worries include the ongoing trade war between the US and China; the potential for an emerging markets debt crisis sparked by a strong dollar; global debt levels; as well as lofty developed stock market valuations, particularly in the US.

Then there is Italian debt to add the concerns over the Brexit debacle. We’ve recently seen big declines in technology stocks, which is not surprising given that valuations for the sector provide no margin of safety.

Stocks with expensive valuations — glamour stocks — have been hit hard but so have so-called value stocks, although relatively less so.

Defensive assets have been hit with bonds and gold. There seems nowhere to hide for the investor, after nine years of strong equity gains. It is definitely time to rebalance.

Last year was a difficult year for most types of investors. But investors never have total control. What matters is how well we manage risk and how flexible we can be in making our investment decisions.

Valuation has always been a poor predictor of returns in the short run, but over the long run, it works out. Pay a high price and you get low returns in the long run. Pay a low price and you get high returns in the long run.

Since the global financial crisis ended, growth stocks have significantly outperformed value stocks.

Looking further back, however, we see that value stocks outperformed growth stocks for roughly a decade leading up to the financial crisis.

Value stocks are typically defined as shares that trade at a significant discount to their true value, sometimes known as the intrinsic value.

Value stocks are usually those of mature businesses whose stocks have experienced temporary earnings setbacks, or suffered due to political or economic events which have hurt their industry.

Value stocks can be found in emerging markets, Europe, the UK, and in commodity stocks.

We feel that developed markets could be in for a rough ride, especially the US. Our reasoning is simple: US Treasuries provide a lot of competition with US equity valuations.

It is a different world when you look at interest rates in Europe, the UK, and Japan. Interest rates there are so low they offer no competition at all to equities.

Most human beings make their investment decisions based on things that are already known and this causes markets to overshoot in both directions.

We think markets have discounted a lot in emerging markets and we find their valuations attractive.

We think Brazil is compelling. And emerging market bonds look attractive despite the turmoil.

Investing is about seeking out opportunities where cheap assets, or value, are showing strong relative momentum on a quarterly basis.

Buying value will not only outperform over any three-year rolling period of time but it is also a fact that you suffer a lot less during major downturns when you own cheap assets, particularly when debt levels attached to those assets are low.

Until recently we have been in an environment where ‘value’ has exhibited weak momentum and ‘glamour’ or expensive valuations exhibited strong momentum. We feel that is about to change.

Back-tests going back to the 1800s show us that not only do value stocks outperform growth stocks, they also suffer significantly less downside.

From a statistical standpoint, it is highly unlikely growth investing will continue to be the best financial discipline for investors over the next 10 years.

Before the dotcom crash of 2000, technology stocks were all the rage. At the time, no-one wanted to hear about tobacco, construction or commodity stocks — all of which turned out to be extraordinary investments over the long term.

Each economic cycle is different, so we are not necessarily advocating tobacco, construction, or commodity stocks.

We do not advocate continual switching nor are we able to predict the future.

This is a moment when there looks to be a change in this economic cycle and adjusting strategy now could be very valuable on a five to ten-year horizon.

Peter Brown is the founder of Baggot Investment Partners. He is at baggot.ie and pbrown@baggot.ie

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