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Portfolio Manager, Senior Research AnalystMore articles
When will the global pandemic come to an end? What will happen to inflation? Will “tapering” lead to a “tantrum”? While these are some of the big and difficult questions swarming around investors’ minds today, we think investors should focus on what’s essential and be wary of what’s in favor – for example, the recent rallies in growth and value stocks.
Rather than tackling difficult macro questions, we look at business fundamentals – companies with predictable earnings power at reasonable valuations – that can protect investors from a storm on the horizon. In our view, carrying an umbrella when leaving home, while inconvenient when the sun is shining, is a sensible approach.
When we look at recent market performance, we generally find two categories of stocks that have rallied particularly hard: high growth and value. Last year, investors with greater exposure to the growth segment – shares of technology companies, for example – enjoyed better performance, largely courtesy of low interest rates. Moreover, central banks indicated that these would remain low for an extended period, which in turn led the market to factor in meaningfully lower discount rates. This benefited equities in general, and growth stocks in particular, as they are seen as more sensitive to changes in interest rate levels.
While the market’s reaction was not irrational, we think it is important to consider a portfolio’s aggregate exposure to this group of stocks. Currently, loose fiscal policy is producing inflationary pressures, which may necessitate rate increases sooner than consensus expectations. In that scenario, high-growth stocks would suffer a reversal of fortune, as they are more vulnerable to rising interest rates.
Towards the end of the year, and into 2021, value stocks – businesses previously hit hard by the pandemic such as banks and airlines – surged. That was the second most powerful value rally over the past 60 years. In fact, value stocks have underperformed the overall market for the last decade, and a correction of the valuation discount was long overdue. However, value’s upward move was short-lived. Banks, for instance, may have surprised with strong earnings, but they also remain prone to cyclical deterioration in the quality of their loans.
Some investors could attempt to time the market, rotating between speculative growth and value stocks. This might make sense as a short-term trade, but timing markets is a difficult, if not impossible, task for even the most experienced investors. A market rotation is not usually obvious until well into it, coupled with many false starts and stops. We believe the protection – the investors’ umbrella – is to invest in high-quality companies, with stable, predictable businesses, bought at sensible prices.
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