Investment Insights

What underpinned value’s ‘flash rally’ in September?

What was the context for the short burst of stellar outperformance value-oriented investments enjoyed in the middle of September – and are there any wider lessons investors can take from the episode?

12/11/2019

Andrew Williams

Andrew Williams

Investment Specialist, Equity Value

Value-oriented investments enjoyed a burst of stellar outperformance in the middle of last month – a turn of events that not so long ago would have provoked little in the way of comment from us, here on The Value Perspective.

After a decade when growth investors have unquestionably been in the ascendancy, however, this all-too-brief episode is worthy of further analysis.

Before we go any further, let’s be clear: we are in no way arguing this ‘flash rally’ is a sure sign of things to come.

The week of 9 September – when some value portfolios outperformed their growthier peers by around 400 basis points – was certainly very welcome but, given the first eight months of the year had seen growth forge some 1,200 basis points ahead of value, we were hardly rushing to crack open the champagne.

That said, we are still inclined to celebrate the episode on the strength of the two very interesting questions it raises: how might it have come about and what, if any, lessons can investors take from it?

With the help of two research notes published that week – one by Société Générale and one by UBS – let’s consider the context of value’s flash rally.

The flash rally

We strive to avoid imposing any kind of narrative on any investment because it only serves to distract from an objective assessment of its associated risks and potential reward. As such, we set greater store by the destination reached than the analysts’ opinions on how we might have got there.

Objectively, then, we wholeheartedly concur with the SocGen analysts’ view that value stocks are extremely cheap and quality stocks or ‘bond proxies’ expensive while skating past their accompanying narrative of “a polarised equity market created by collapsing bond yields”.

At the same time, we are intrigued by the UBS analysts’ argument for why investors have placed such an extreme valuation premium on growth stocks.

Again, we will ignore how they see the details of the journey and focus on where they believe we have reached – essentially, an environment where investors’ demand for fast-growing businesses is far exceeding the available supply.

As the left-hand chart below illustrates, in the early 2000s, three times as many companies in the US’s main S&P500 index as there are today had a five-year growth rate in excess of 15%.

Past performance is not a guide to future performance and may not be repeated. 

At the same time, as the right-hand chart shows, demand for growth stocks has shot up in the last couple of years. “One result of this supply and demand imbalance is the extreme valuation premium investors have placed on growth stocks today,” add the UBS analysts – before offering the following chart and the observation the last time the premium was at this level was “the height of the tech bubble in the early 2000s”.

Past performance is not a guide to future performance and may not be repeated. 

What was the cause of the rally?

Now we have offered some context for last month’s flash rally in value, you may well be wondering about what the cause could have been.

As you would expect, our analyst friends have their own theories while we of course would argue it all comes down to valuation – tightly-stretched elastic snapping back, if you will allow an analogy rather than any narrative.

Ultimately of far greater importance than any ‘trigger’, however, are two lessons that can be taken away from this episode – one by investors in general and the other by value-oriented portfolio managers, such as ourselves.

Lesson 1: Diversify style exposure

The big lesson of the flash rally for equity investors in general, then, has to be the importance of diversifying their style exposure.

Directing money towards different assets on the basis that, even if some are falling in price, others may well be rising, is a pretty solid approach to investment – and one should apply every bit as much with regard to style as it does to, say, geography, company size or industry sector.

Put simply, if you are not diversified by style, any larger-scale value recovery in the future is going to hurt.

Lesson 2: Stick to your guns

The other big lesson, we believe, is for value-oriented portfolio managers, such as ourselves – and that is the importance of sticking to your guns.

We enjoyed the full benefit of the flash rally because, no matter what is happening in markets, we pursue a value strategy – and always will. This is why people invest with us and any ‘drift’ in style by us would be a betrayal – of their faith and our principles.

We are in no way arguing that that one week in September is a sure sign of things to come but it should serve as a reminder the future is uncertain and investors should always look to position themselves for a range of possible outcomes.

Certainly anyone who takes the view value will come good can rest assured that  we will not waver from pursuing just such an investment strategy, which almost 150 years of historical data suggests could, over time and on average, outperform the wider market.

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