As an acolyte of Dr Benjamin Graham and Sir John Templeton, I have a intellectual fascination with the principles of value investing, even if psychology/momentum in the financial markets often does not make this an optimal strategy. Value investing simply does not work when markets are in a go go, wildly bullish mode, as in the late-1990s dot-com mania, the 2004-06 credit bubble or the Fed QE fuelled, post Lehman bull market since 2009. Growth and momentum, not value, mints money during such protracted bull markets on Wall Street.
Value investor who buy shares with low price/earnings ratio or price/book value multiples unquestionably lag in performance relative to their more adventurous “growth” peers. Patience is a greatly undervalued commodity in the stock picking business. In the past decade, value has trumped growth for 7 out of 10 times. As an investment discipline, value is no longer a winning strategy for most fund managers.
Retail investors have not abandoned value funds, unlike during the tech/Internet bubble of the late-1990s. The sharp rise in stock market volatility and US Treasury bond yields in 2018 is also an argument to accumulate value, not momentum stocks. In the past decade, central bank money printing, notably the Bernanke/Yellen Fed’s quantitative easing policies led to a dramatic fall in the Volatility Index, making investors vastly more tolerant of balance sheet risk even as low economic growth rates gave a huge valuation premium to companies that could gross EPS by 20 per cent a year. This macro milieu made value investing the Cinderella (ex-fairly tale prince) strategy in the US stock market. However, the money game has changed on Wall Street. The Powell Fed will shrink its $4.5 trillion balance sheet. The yield on two year US Treasury note is at a post Lehman high. Regulatory and political risks have the potential to derail even some of Silicon Valley’s growth stocks, as the recent fates of Facebook and Amazon attest.
Wall Street folklore and empirical data since the Great Crash contends that rising interest rates are a green light to switch from high to low P/E stocks in the quest for value outperformance. Of course, the meteoric rise of passive investing has favoured high multiple growth stocks and dissed low multiple value shares.
The brutal derating of financials, after the 2008 global banking crisis, meant that this quintessential value sector was also the worst performing sector of the past decade. Energy, Wall Street’s other value sector, was gutted by the 2014-16 oil price crash. Technology, the darling consensus overweight of global markets, is a growth and not a value sector. Value investing is often the optimal strategy when corporate America’s earnings per share growth accelerates. This is happening in 2018. The spectacular rise in oil prices also means Big Oil supermajors, unloved and neglected, could once again find favour in the stock market as my top pick Total did in the past three months.
The world’s preeminent media conglomerate Walt Disney is a classic value stock. At 100, the Magic Kingdom trades at a mere 13.6 times forward earnings, way below its 52-week high of 116. Walt Disney owns the most profitable movie studio in Hollywood, iconic theme parks in Florida, California, Paris, Hong Kong and Shanghai, the cable sports colossus ESPN, global franchises like Star Wars and Marvel. Disney used to trade at 20 times earnings three years ago but Wall Street has unjustifiably devalued its prospects even as Netflix shares have surged 900 per cent in the past 5 years.However, Disney has clear catalysts to move the shares higher – from its bid for 20th Century Fox’s movie/cable assets (Sky, Star TV, Hulu, etc) to its new direct to consumer streaming strategy to the sheer growth of its iconic theme parks all over the world. Even without the prospect of multiple expansion, Disney EPS and thus its shares could well grow 20- 25 per cent in the next two years.
Despite higher US Treasury bond yields and Trump’s promise to “do a number” on the Dodd-Frank regulatory burden, US money centre banks are down 8-10 per cent from their 2018 highs while the S&P Financial index fund has been a mediocre underperformer. This is due to both profit taking and a fear that a flattening Treasury bond yield curve presages recession risk. However, as loan growth rises, bank EPS growth can well rise 10-12 per cent in 2018, a prospect not discounted in money centre bank valuations. Selling 3-month, at the money put options on the S&P Financial index fund (XLE) at 27 can enable investors to unlock the sector’s value metrics.
The writer is a global equities strategist and fund manager. He can be contacted at email@example.com.