16 May 2018, 16:44 GMT
One recurring theme of recent client meetings has been a discussion of the outlook for value investing relative to growth. The subtext often seems to be that value might finally be ready for its moment in the sun, after years of being left in the shade by the growth style. Although value did indeed spectacularly underperform growth in 2014 and 15, since 2016 this has entirely reversed in the UK, and in fact value is now slightly ahead over 5 years. However, this is not the case in other global markets.
Source: Thomson Reuters, Fidelity International, May 2018.
Politics is a red herring
Taken in isolation, UK political worries might be expected to push investors towards defensive growth stocks rather than more cyclical value areas. However, when considering the UK market overall, we are generally talking about large, global companies not likely to be affected much by domestic UK politics.
The key difference lies in the types of large global companies listed in London compared to other markets. It is sector weightings, rather than politics, that help explain why the strong performance of value in the UK has not been repeated globally.
The UK information technology sector constitutes less than 1% of the index – the lowest of any major global market (the US has 25%, for example). The UK’s biggest technology stocks are Sage and Micro Focus and though they may have their attractions, they are not exactly household names leading the digital disruption of the global economy.
While we may not have much in the way of big tech brands in the UK, we have plenty of consumer brands owned by global groups such as Reckitts, Diageo and BAT. Large cap growth in the UK has been much more weighted towards these sorts of defensive consumer staples than disruptive tech. These stocks developed a strong correlation to the bond market, which helps to explain why they performed so well throughout 2014 and 15, but also why they were so vulnerable to a de-rating as discount rates rose. A lack of exposure to the digital economy narrative also partly explains why the UK index has lagged other markets.
Source: Thomson Reuters, Fidelity International, May 2018.
Along with consumer staples, the UK market boasts bucketfuls of commodities. Among the value sectors, this group has been a stand-out performer over the past two years, with demand from China holding up better than expected, allowing the stocks to recover from the desperately unloved levels they were at in 2015.
Source: Thomson Reuters, Fidelity international, May 2018.
Re-assessing the value vs growth debate – focus on the stocks
In mid-2016, we argued that the gap between value and growth stocks in the UK had become unsustainably large, and that there was a strong case to position for a mean reversion in favour of value. Today, stocks seem more evenly priced and arguably more connected to economic fundamentals. As such it does not seem appropriate to paint the market with broad brushstrokes.
Value investors can draw confidence from the well-established fact that their style outperforms the market over the very long term, and we fully expect this relationship to persist in the future. However, whether value or growth takes the lead over the next year or two is likely to be determined by changes in the macro-economic environment, making short-term predictions difficult or even impossible.
With input and financing costs rising, consumer behaviour evolving, central banks changing policy, and sentiment generally positive, it seems certain that today’s market will be one of large relative winners and losers. But at this point it is too reductive to paint stocks simply as value or growth. We should look beyond these labels, towards rigorous and differentiated fundamental research and performance driven more by stock selection than by style bias.
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