This week's Portfolio Picks is from guest columnist John Husselbee, who asks whether it's time to start heading to value, rather than growth.
Looking at our portfolios heading into 2018, equities clearly remain more attractive than bonds and cash but we are wary of complacency after a year in which global markets were up close to 20 per cent.
Against such a backdrop, we continue to look to buy favoured areas when they are cheap and are currently eyeing an opportunity in value stocks, where performance remains far removed from surging growth companies.
We see this as a broad trend, most obvious in the US, but also prevalent across Europe, Japan and emerging markets.
Value investing has a long-term track record – championed by the likes of Warren Buffett – but followers of this strategy have suffered a lost decade since the end of the financial crisis, the longest sustained stretch of underperformance since the Great Depression.
By its contrarian nature, value often endures periods in the wilderness but the current malaise compared to growth names (encapsulated by the FANG stocks – Facebook, Amazon, Netflix and Google) has been so prolonged that Goldman Sachs research last year debated whether value investing is dead.
In an environment where earnings matter more than future prospects, value names come to the fore.The investment bank concluded it is too early to give up on value and current ‘unfriendly conditions’ are unlikely to persist. But as many commentators, including us, were also talking up the opportunity at the start of 2017, investors can justifiably ask what is different now.
We would point to several interconnected signals why 2018 may be a good time to increase exposure to this cheaper end of the market via funds such as Fidelity Special Situations.
Strong performance from growth stocks since the financial crisis is understandable, with investors willing to pay up for companies able to outgrow a sluggish global economy.
According to Goldmans, ongoing ‘secular stagnation’ has clearly inspired investors to favour stocks capable of generating their own growth over value names.
That has supported the FANGs and many others whereas financial companies – a bastion of value as much as technology is of growth – have spent the last decade weighed down by ever-increasing regulation.
Particularly in the US, the gap between growth and value has reached historic levels and we see a solid case for this starting to unwind in the shape of President Trump’s tax cuts.
Wherever you stand on these politically, consensus suggests the positives for corporations and individuals could boost many sectors of the economy in 2018 and if Trump continues his deregulation plans, financials are an obvious beneficiary.
In contrast, value began to rally in 2016 and into 2017 after central banks looked to be stepping away from austerity, realising monetary stimulus had reached the end of the road and governments needed to dig into their own pockets to stimulate economic growth.
This recovery faltered however as Trump’s policy initiatives – including healthcare reform – stalled and little progress was apparent in areas such as infrastructure.
Value stocks tend to outperform when an expansion is broad-based and relatively robust – generally at the start of an economic cycle – and there are signs we may be coming out of the sluggish growth of recent years.
We are currently in a rare period of synchronised global growth, with two thirds of the countries tracked by the Organisation for Economic Co-operation and Development (OECD) accelerating from 2016.
Something else to bear in mind is that the high-flying FANG stocks have posted earnings that do not necessarily match their expensive valuations and at some point, investors will want to see a closer relationship between the two.
Whispers of another tech bubble remain muted for now but in an environment where earnings matter more than future prospects, value names come to the fore.
A final driver for value is the downside protection these fundamentally cheap stocks can offer after a decade out of favour.
While no one is ever keen for a downturn, we have long been surprised not to see the kind of 5% to 10% correction that has traditionally been a function of healthy markets.
We are not expecting a prolonged bear period, which is typically preceded by economic recession, but if there a correction, growth stocks would bear the brunt of any selloffs.
John Husselbee is head of multi-asset for Liontrust
