As we approach the end of another year, the equity bull market shows no sign of abating. Nine years after the financial crisis, equities have been on a stellar run with a seemingly constant move higher with little volatility, in what is becoming known as the most hated bull market in history.
When Quantitative Easing was announced by central banks, many suggested it should be called ‘the Great Financial Experiment’. While the overall aim was to underpin the economy and ensure that credit continued to flow to businesses to promote growth, one of the implications has been the rapid advancement of technology, fuelled by access to very low financing costs and the exceptional performance of growth stocks, particularly in the technology space.
As a result, when looking at investment styles during 2017, growth investing has significantly outperformed value investing, and since the financial crisis growth has outperformed value in seven out of the last nine years*. Unsurprisingly, this has meant that value investing as a style has fallen hugely out of favour, with only the value teams at Schroders, Jupiter and JO Hambro really falling into the true value camp.
Those of you who, like me, remember the technology bubble in 1999/2000, will recall that equity valuations in growth sectors got incredibly stretched and many value managers of the day were being told they had lost the plot and needed to change their investment style to reflect a new world. Well, you may also recall that value went on to outperform growth in each of the following seven years!In those heady days of the technology bubble the mere hint of an internet connection saw a company’s valuation sky rocket. Things are different to today, but growth stocks are once again priced on very high multiples. Interestingly, November saw the elevation of online takeaway company Just Eat into the FTSE 100 Index and it now trades on a PE multiple of 73**. While I have no doubt that Just Eat is a great company that is capitalising on the changing way we are leading our lives, paying 73 times its current earnings to own a slice of it is a very rich price indeed.
The challenge for these highly valued growth stocks is that they must keep on growing at the same phenomenal rate to justify their valuations. With genuine growth seemingly hard to find, it is no surprise that some are prepared to pay these high prices to access such growth. However, it’s important to remember that there is no margin of safety and any disappointment in trading is likely to see their share prices hit hard.
It’s these valuation anomalies that are exciting value managers and giving them hope that the dispersion between value and growth has gone too far. With businesses such as Just Eat – which, remarkably, is now worth more than Marks & Spencer, J Sainsbury and WM Morrisons – priced for perfection, it is the old fashioned industries of mining, oil and gas extraction, insurance and telecoms that are currently the laggards and trading at significant discounts to their history.
While these businesses may not be exceptionally glamourous, and certainly not as exciting as ordering a takeaway on your phone while settling down in front of the Strictly Come Dancing Christmas Special, there comes a point when the valuation anomaly becomes just too great and these businesses get too cheap. When looking at the current dispersion between value and growth, it feels like this has been stretched to extreme levels.
As we enter 2018, the economic environment is changing, with inflation running high, the prospect of higher interest rates and a potential slowdown in the UK as the headwinds of Brexit begin to bite. If this spills over into the investment world, it will be interesting to see if it is those businesses priced on high PEs that provide the protection or whether it is cheap stocks that weather the storm the best. A look back at both 2000 and 2008 gives a clear pointer that if we do hit a period of turbulence in the economy and stock market, then value investing could well be the place to shelter.
Ryan Hughes Head of Fund Selection, AJ Bell InvestCentre