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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 last month – and are there any wider lessons investors can take from the episode?

01/10/2019

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?

We address the latter point here but first, 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

As we  have argued before in articles such as Two sides to every story, here on The Value Perspective, we do 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. You will find these lessons here.

Author

Andrew Williams

Andrew Williams

Investment Specialist, Equity Value

I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm. 

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Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.