The state of value, Ben Inker and defensive strategies
The best investment research, blogs and podcasts this week
After years of stop-start, so-so performance, the value factor had a much stronger year in 2022 and into 2023. With inflationary pressures scaring investors out of growth, attention turned to the predictable current cash flows in larger (and cheaper) shares.
But in March - when we got what some feared was the start of a mini banking crisis - value started misfiring again. A solid performance by banking shares made them a kind of pro-cyclical value trade in 2022. But faced with the possibility of major problems, the sector sold off sharply in March.
In this note from Alliance Bernstein: Q2 2023 Strategic Investment Outlook, they argue that despite the turmoil, there’s probably still a good case for sticking with value for the time being, but perhaps steering clear of too much exposure to banking/financials stocks.
“We were already cautious tactically on value exposure going into this episode (we’ve been tactically positive on low volatility and free cash flow yield—and remain that way).”
“There’s still a positive strategic case for value in a higher-inflation world that isn’t changed by the recent turmoil.”
“We… reiterate that there’s a case to reduce financial weightings in non-sector-neutral value, based on the view that real yields will remain subdued per unit of inflation, given long-run macro forces.”
On the subject of value, this podcast (and transcript) from The Value Perspective is worth a look: The Value Perspective Podcast episode – with Ben Inker. It’s an interview with Ben Inker of US asset manager GMO (as founded by Jeremy Grantham), and it goes pretty deep on some of the subtleties of value and how it changes over time
Here are a few highlights:
On Jeremy Grantham…
“So it can be a little bit terrifying thinking about how much he can recall of the last 50 years of investing – but he has been an astonishing person to be able to learn from.”
On Grantham’s focus on bubbles…
“Over the course of his career, what he has noted is, periodically, something sufficiently extraordinary will go on in the markets as to have the potential to ‘wash away’ the benefits of coming in and doing your job day-by-day. And when markets get to crazy prices, that is predominantly where extraordinarily losses come from.”
On the drivers of value…
“In 2000, value stocks were trading an extraordinary discount to the market – it was the opportunity of a lifetime – but, by 2005, they were a lousy investment. So that is not directly about heuristics – that is about having the discipline to make sure you understand where the returns have come from, for the asset you own; where to expect those returns to be coming from going forward; and whether that asset – be it value stocks or the S&P or anything else – is priced to deliver what you need from it.”
On the power of the discount…
“One of the things people do not seem to understand about value and value investing is it’s not just about mean reversion. The charm of value trading at a bigger discount than normal is not simply, ‘Well, it’s going to come back up and trade at a smaller discount’ – it is that rebalancing within value is going to be so much more powerful when value is trading at a big discount.”
On value in the banking sector…
“Now, you do tend to be overweight financials in value. You don’t have to allow yourself to be but, when we look at financials today, we see a bunch of financials that really do look pretty cheap – and we think it makes sense to own some. We also think it makes sense to recognise financials are a slightly tricky group because they are one kind of stock where looking really cheap can be a problem, right?”
A defensive approach to shares… with one eye on recovery
With the interest rate-hiking cycle widely believed to be nearing an end and all eyes on which way the economy will land. How things go could have a significant impact on company earnings, and that presents interesting questions on what to look for in stocks right now.
This paper from Janus Henderson reckons on maintaining a defensive view with a sprinkling of cyclical and mid/small-cap exposure to catch the recovery when it comes: When market volatility creates opportunity
Here’s a summary:
Recent (in March) turmoil in the banking sector has frayed nerves even more - especially in equity markets
We’re very much “late cycle” with central banks coming toward the end of their period of rate hikes
Equity investors should prioritise quality, defined as companies with sound balance sheets that are capable of generating cash flows throughout the cycle
Tighter access to consumer credit and higher input costs will likely dent earnings and compress valuation multiples as a result
Investors with the appropriate risk tolerance should embrace volatility with the aim of identifying quality companies with attractive valuations
Exposure to the defensive healthcare sector merits consideration. Biotechnology holds particular promise given attractive valuations and its exposure to innovation
As markets are forward-looking, investors might consider profitable small- and mid-cap companies as they tend to outperform early in a recovery
If things continue their current trajectory, the cyclical nature of European stocks means that they have historically been well positioned to outperform as the economy moves toward recovery
This chart (below) from the research shows that forward PEs on UK stocks are currently -27.8% below their 10-year median average. Only Italian shares are trading at a deeper discount.
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