Investors must see growth in the context of history – Dan Rasmussen

Investment can often seem like the Thunderdome – the post-apocalyptic gladiatorial arena in the last of the original Mad Max film trilogy where, as creepy master of ceremonies Dr Dealgood would intone, ‘Two men enter, one man leaves’. Diversification may be a key principle of portfolio construction and yet there is an awful lot of ‘versus’ bandied around, such as active v passive, equities v bonds and large company v small.

And, of course, value v growth. Here on The Value Perspective, we may have argued the case for including both styles of investing in a portfolio in articles such as Lessons from 2020 and Basic rule, but this remains a highly divisive subject where, at one end of the spectrum, you will find people who believe there is no price too high to pay for growth and, at the other, those who see growth as speculative and very hard to predict.

As a result, the latter group – among whom you will tend to find value investors – will do all they can not to overpay for growth. Indeed, if all goes well, they might be able to get it for free. Nevertheless, over the last decade, it is the former group who have undeniably been enjoying the better run – leading, with a grim predictability, to the latest round of arguments as to why value investing has passed its sell-by date.

Deep value investor and author Dan Rasmussen has some strong views on how investors should think about growth – so strong in fact that most people would think twice before joining him in the investment Thunderdome – and so we wasted no time raising the subject when he joined us recently as our guest on The Value Perspective podcast.

Rear-view mirror

“Investors like to look in the rear-view mirror,” he begins. “They ask what has worked over the last five years or the last 10 years – and that is basically the height of their sophistication, right? So they might say, gee, Chinese venture capital is really a deep area of interest to me! Or I am really excited about SaaS [software as a service] because I’ve always had conviction around recurring revenue as a driver.

“Then they look at value and see things are getting disrupted but what if the market had gone the other way?

Let’s just set Big Tech aside because that has grown a lot – that is just a truth. We have been through this 10-year period where big growth companies – Microsoft, Apple and so on – exceeded forecasts and grew an astonishing amount. There is a real element to why those stocks have done so well.

“In a lot of cases, however, the broader picture of growth versus value is one of changes in multiple – but that could have gone the other way and we would have come up with a totally different narrative. So rather than looking at what worked over the last five or 10 years, building a narrative to explain that and then projecting that narrative forward, investors should look at long-term base rates and the long-term scope of history.

“Then they need to ask, how often has that been true? What are the drivers? And can we predict those drivers more accurately than we can predict the outcome? If you step back and look at the long sweep of history, the last decade looks very much the same as the 1990s. Both periods saw a long economic boom, falling interest rates and a great deal of technological innovation.

The sweep of history

“In the 1990s, it was the internet and the personal computer and then, over the last decade, it has been the cloud, SaaS and internet 2.0 or 4.0 or whatever we’re calling it now. And a huge amount of optimism has sprung up around that – along with a lot of speculative technologies, such as electric vehicles, 3D printers and so on.”

It may not feel like it because the experience is so recent in our minds but, for Rasmussen, those types of decade are actually quite rare when looked at “in the big sweep of history”. “You see a lot of other economic environments,” he points out. “You see periods like the 2000s, with two big recessions in the US, and you see periods like the 1970s, where you have a stagflationary environment.

“You can have all sorts of different economic outcomes that lead different stocks to perform very differently and I would argue that, over the long term – and absent the big growth wave and rising fashion and falling rates and stable economic growth that have driven this quasi-bubble behaviour and technology stocks – the one long-term way to manage money is to find things that are out of fashion that come back into fashion.

“It is not going to work every decade – and obviously it has not worked over the last decade – but it is an approach that is going to make money in choppy markets and it is going to make money in inflationary markets. That is because you are arbitraging that fundamental element of human psychology that never goes away, which is excesses of optimism and excesses of pessimism that are both a feature of markets.”

Heterogeneity of views

Rasmussen accepts this stance flies in the face of popular theories, such as the so-called ‘efficient market hypothesis’ – the idea asset prices instantly reflect all available information – but continues: “I disagree with that view because I think markets are driven by humans. Two very smart investors can settle on very different forecasts on one stock – and the more investors you have, the more heterogenous those forecasts will be.

“And you know what? You and I can debate all we like about, say, a business’s 2022 growth forecasts but, until 2022 actually happens, neither of us will know who is right. We can all have our beliefs about the future and no-one can prove us wrong. And what creates market opportunity and market volatility is precisely that heterogeneity of views.

“What value investors are fundamentally doing is suggesting the world is a little bit more uncertain than others might think – for example, maybe we shouldn’t be so pessimistic about energy. Maybe people will still be using oil 10 years from now. Maybe half the cars driven will not be electric in 10 years. And maybe those electric vehicles will not be at massively different profit margins than the non-electric vehicles.

“Maybe – just maybe. And so maybe we should not have such optimism about one side of the trade and such extreme pessimism about the other. Maybe we should be willing to take the other side of that bet – knowing nothing about the stocks other than their multiples and the amount of consensus optimism priced into one side of the trade and consensus pessimism priced into the other.”