Fees wreck returns, Dan Rasmussen, tech rebound, European markets and growth looking up
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Oh man… I’ve lost count of how many times over the years I’ve referenced the classic Barber & Odean research into how individual investors wreck their own returns: Trading is Hazardous to Your Wealth. The study was published in 2000 and covered a period from 1991 to 1996, a time when cheap online trading was still a distant hope. In simple terms, they found that investors were far too prone to overtrade their accounts, and when they did the costs killed their returns.
I won’t ruin this article by Joachim Klement, who sums it up perfectly: Costs are certain, so what happens when you remove the costs? But a new study using much more up to date eToro accounts in an age of cheaper trading, runs a similar experiment. And the result…
Overtrading and costs will still kill your returns. Check this out…
Dan Rasmussen on deep value
Dan Rasmussen is CIO of Verdad Advisors (a value-focused investment firm) and this podcast is a really excellent perspective of a US investor looking around the world for value: The Value Perspective with Dan Rasmussen 2.0.
Here are the highlights:
Trends over the past decade:
2018-2020 was a terrible time for value. If you ranked factor styles at that time, the very best performance came from expensive, unprofitable, speculative stocks
If you bought the cheapest, highest yielding, highest free cash flow yielding, most profitable businesses, you did terribly
Verdad examined the times when value works better and found that economic crises and recessions have historically been the best times
Why? Value investing is about expectation errors: trying to buy something where the market has expectations that are way too pessimistic
They raised a fund to do this during Covid and did very well
How out of favour is deep value?
In the decade up to 2021 it was a really simple story: US large cap technology versus everything else. Everything was doing much worse by comparison to US large cap tech.
Two thing happened as a result of this:
The surge in passive investing was driven by the exceptional performance of the S&P 500 (which was driven by US tech)
People’s active bets focused on private equity, which saw a massive surge
The minute you step out of this world, you get into areas that have been neglected for 10 years - many of which are now attractive (small-cap, international)
People tend to anchor on the past three years
Verdad research shows that recent memory shapes how people make probability judgments. Recent salient events skew how people think and behave
The are various factors - including age and our ability to connect probabilities to lived experiences - that shape how we behave and the decisions we make and how we invest
Investors tend to be anchored by what has happened over the past three years - it shapes what they’re willing to bet on
This can be affected by fads in markets - crypto, large-cap tech, 3D printing, AI - people remember that fads actually do well for a time
You only need one year of change (value working in 2022 or the resurgence of bond markets) for people to start realising that there are alternative investment options
What could trip up deep value?
With deep value you are always overweight companies that are sensitive to economic developments. When bad economic developments happen, deep value stocks don’t magically outperform - they tend to get whacked even more
Deep value stocks tend to be smaller in size and not that sexy, so market liquidity also plays a part - it enhances volatility
The good thing is that with deep value, you know the risks. But with glamorous growth stocks it’s hard to know what the risks are
A contrarian view of Porter’s five forces
Porter’s five forces is a competitive strategy framework. These frameworks are really all about relative market share mattering. The more market share you have, the more market power you have, which leads to higher margins
In the 1970s and 1980s, monopolies were seen as bad and anti-competitive by authorities, so Porter formed a view that they must be good for investors
This is a beloved idea of value and quality investors - but it has been completely discredited by economists and the law. There is no correlation between market power and margins
Amazon’s online retail business is a good example. Amazon seems to have a massive market share but consumers are not harmed by it - they have more choice and lower prices. This is a paradox - and it doesn’t necessarily lead to high margins
There are parts of Porter’s thinking that don’t make empirical sense - there is no study that shows it works
The Europe opportunity
A year ago, everyone was bearish on Europe: Russia/Ukraine war, energy crisis, perception of less innovation than the US, and the UK was a litany of economic horrors
Over the past year the probability of recession has come down a lot. European stocks have been on a tremendous run, particularly in value stocks
In Verdad’s view, Europe is really cheap and priced for a big economic storm that seems less likely
Places that are most interesting are Poland (so cheap) and Sweden (cheap relative to its own history) - although there are only a few investable companies
AI driving the tech sector rebound
The massive gap-up in the share price of US tech giant Nvidia in late May was impressive for a few reasons. One was that you don’t see too many mega-caps shift by a massive 25% in one day. But on May 25, Nvidia added $184 billion in market cap to take it past that magic $1 trillion.
What made this all the more remarkable was that Nvidia stock fell by 50.3% in the 2022 tech sell-off. Like the rest of the ‘big seven’ tech giants (the others being Meta, Amazon, Alphabet, Microsoft, Tesla and Apple), last year was tough - but that’s almost all forgotten.
At the heart of all this are new trends in technology that are capturing investor imagination - Artificial Intelligence (AI) being the main one.
This chart of the week from Goldman Sachs gives a strong hint of just how interested the market is in AI. It shows the proportion of companies referencing AI in their recent Q1 earnings calls. Those referencing AI the most were Comm Services, IT and Consumer Discretionary sector stocks - which have all seen the strongest returns so far year-to date:
UK and European shares poised to outperform?
UK indices have been pretty flat year-to-date, with the FTSE 100, 250 and SmallCap all barely unchanged. The more speculative AIM market has continued last year’s downward trend, albeit more gently, giving up around 5.6% since the start of the year.
In Europe, the story has been stronger. The German Dax is up 13%+, France’s CAC is up 9%, and the FTSEurofirst 300 (ex UK) is up by 9.6%. And in the States, of course, with US tech giants running riot again, markets have been even stronger.
So where does that leave markets here in the UK and Europe?
Well, from the UK perspective, this note from Martin Currie’s Ben Russon (Franklin Templeton) reckons there are reasons to be optimistic: UK equities—shifting to a more positive narrative.
“We believe that if investors hold the line and keep positions in UK stocks and sectors that are tied to the domestic economy, consumer confidence and retail spending, then there are value opportunities as conditions improve.”
It points to a series of factors that should inspire some confidence:
The UK economy is defying the gloomier predictions and is proving more resilient than first feared
The British pound has strengthened (towards parity with the US dollar), it is still at the bottom of its historic range - making UK assets attractive to international buyers.
Corporate balance sheets largely appear to be in good health, despite the uncertain economic outlook
Corporate debt is at very manageable levels, meaning corporations are in a good position to absorb rising finance costs as interest rates increase
The UK equity market “looks attractive to us” on an historical basis with a price-to-earnings (P/E) ratio of around 11x
The valuation of the UK equity market also looks more attractive versus its international peers, with the MSCI UK Index 12-month forward P/E at the bottom of its historic range relative to that of the MSCI World Index
Investment strategy: Focus on valuation. Prefer high-quality, dividend-paying UK companies that can provide resilient and growing income streams. UK companies that derive a large portion of their revenues from overseas are well-positioned to benefit from an eventual turnaround in the global economy
From the Europe perspective, this note from Janus Henderson suggests the region could also be poised to perform well: The case for Europe.
Higher inflation and higher rates play to the advantage of value-oriented European markets, and could mark a turning point (after years when growth flourished versus value)
A European ‘catch up trade’ has already begun
European central bankers have been slow to respond to crises since the global financial crisis. But that has changed - and today, policy makers are moving much quicker. Reaction to inflation has put the continent in a strong position
European and UK shares look much cheaper than US shares
Does the growth sell-off herald brighter times ahead
The narrative around much of the poor performance of growth shares (and growth strategies) last year was that investors could no longer easily judge the value of their future cash flows. Inflation, higher rates and possible recession meant that racy valuations based on high hopes for the future were no longer justified. Value stocks (with their known current cash flows) became much more desirable.
This note from Liontrust suggests that things might be swinging around, making growth stocks potentially more attractive again: Sharp sell-off in growth stocks – a good thing?
They keep an eye on the levels (by their measure) of over-optimism in companies. It’s a contrarian measure, so when over-optimism falls it can be a bullish signal.
Here’s how they explain it:
“…aggressive corporate expenditure is often a sign that executives are making overly optimistic growth forecasts which they are prepared to back with significant investment. When in due course the over-optimism is revealed and growth disappoints, the situation is exacerbated by the misplaced investment that has occurred.”
According to Liontrust’s James Inglis-Jones, there was a spike in over-optimism in late 2021. But that gave way to dramatic falls in the US and more steadily in Europe.
After selling off so hard, companies no longer had access to cheap funding and their falling prices meant valuations improved. From here, it’s a part of a market they reckon look much more encouraging…
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