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Short-term value/growth gyrations

Updated: Feb 14, 2023

A tug of war is taking place between value and growth. Up until the start of this year, the winner was growth with the contest turning into a rout in 2020.

More recently, the battle has become more nuanced. The value trade has morphed into the reflation trade, a bet that cyclical companies will outperform as they benefit from a post-Covid recovery. The growth trade has become the tech trade, underpinned by the belief that technology stocks will deliver on their blue-sky earnings growth potential and that the discount rate used to value these earnings will stay at historically low levels.

The chart below shows the weekly performance rank ICs for our Value and Growth composites for the month.

Chart 1: Value Composite Performance May 2021 (Week by Week)

Source: OQFM

Value massively outperformed growth at the start May before reversing course later in the month. The weekly data masks some extreme short-term performance moves. Our portfolio management system – Conquest – allows the portfolio management team to monitor live factor performance data during the trading day. Incredibly in Australia on May 21 and in Japan on May 31, the intraday rank IC for the value composite dipped below -50% shortly after the market open.

It’s a cliché that the four most dangerous words in investing are “this time it’s different”. Markets do undergo structural changes – witness the shift from fossil fuels to renewables and the significant decline in the index weight of Oil & Gas companies - but relative share price moves and overall market valuations are constrained. Hence markets move in cycles. Nevertheless, investors tend to have short memories and/or think there have been structural changes which render past market cycles and share price behaviour irrelevant. The best-known proponent of this view is Cathie Wood who passionately talks about “disruptive innovation”. She also has a $3,000 price target on Tesla. For an automobile company to reach a market capitalisation of almost $US3 trillion, this time would have to be very, very different. Although it’s tempting to dismiss such views as being irrational, the weight of money still supporting this thinking is the reason why the growth trade is staging short-term performance rallies. Every dip in growth stocks is still seen as a buying opportunity.

To see why this is dangerous, consider the following chart. (Disclaimer: I saw a similar chart on GMO’s website which I have replicated below, using my own annotations and data calculations).

Chart 2: Russell 1000 Value – Russell 1000 Growth

Source: GMO, Bloomberg, OQFM

As I documented in a research note earlier this year, there are strong similarities between the current market environment and the late 1990s and early 2000s. And if this time isn’t different, the current value/growth gyrations provide great short term trading opportunities. OQFM’s proprietary portfolio management system (Conquest) facilitates Intra-day screening of large stock moves based on liquidity flows (as opposed to fundamentals) which enables the portfolio management team to take advantage of these opportunities.

It should also be noted that the Fund’s performance isn’t contingent on value outperforming. Value factors are just one of many inputs into the stock selection process. A sustained convergence of valuation spreads, however, would provide a nice performance tail wind.

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