Trick or Treating for all!!!
This is a continuation of my post from yesterday.
why value works less well today
I’m a growth investor by temperament. But I’ve spent more than half of my working career as an analyst and portfolio manager in value shops. My basic contention is that traditional value investing works much less well in a globalized and post-Internet world than it did previously.
Why do I think this?
One of the two basic premises of value investing is that a firm’s investment in plant, equipment, distribution networks and brand name have a value that is substantial and that endures despite current mismanagement or battering by the business cycle. The Internet has upended a lot of this, and the ability to move production to the emerging world has done more.
(The second premise is that change of control–either though action by the board of directors or by outside influences–is possible. True in the US, but very often not elsewhere. Twenty five years of activist investor failure in Japan is the most notable example. But continental Europe is just the same.)
flavors of value
I’ve written about this before. Basically, some value investors buy stocks simply because they’re very cheap, period. Others wait to identify a catalyst for change before they jump in.
Personally, I believe that in today’s world the latter is the far safer course. Yes, you may miss the absolute bottom. But you also have greater assurance that you’re not booking passage on a latter-day Flying Dutchman that is doomed to never go up.
growth and value cycles
Through most of my thirty years in the investment business, periods of value outperformance and growth supremacy were each relatively short and both contained within a four-year business cycle. For the past fifteen years or so, the periods of one style or the other being in vogue have been much longer. I don’t know why. But this phenomenon may make slavish devotion to one style or the other riskier than it has been in the past.
Consumer Discretionary vs. Staples
Back to the uninformative Bloomberg discussion of Consumer Discretionary vs. Staples. Is there anything to the idea that Staples may make a recovery vs. Consumer Discretionary?
Yes and no.
I think conditions are beginning to come into place for Staples stocks in the US to begin to do well again. Many Staples stocks have large international exposure, much of that in the EU. Europe appears to finally have moved past the bottom of its Great Recession and to be beginning to recover. So revenues for Staples companies there should begin to perk up. More important, the euro has moved up by about 7% against the dollar since July. So the dollar value of those recovering sales to a US firm with EU exposure will, I think, be surprisingly high.
It’s possible that a continuation of economy-damaging politics as usual in Washington will make even slow growth in the EU look relatively attractive. A renewed global investor interest in Europe may well cause its currency to remain firm.
On the other hand, Consumer Discretionary has less foreign exposure and a greater tilt toward the Pacific. China’s recent economic reacceleration is therefore a plus. But there’s less chance of currency gain.
If portfolio managers begin to reallocate money to Staples, where will the funds come from? It’s not clear to me that it will come from Consumer Discretionary. It might well come from Energy, Materials, Technology or Industrials–all more cyclical industries than Consumer Discretionary. If so, both Discretionary and Staples might do well. In fact, although I haven’t thought this through enough, my hunch is that this is what will happen.
To me, the relevant points are that Staples are statistically cheap and that there’s a reason to think better times are in store, at least for US-based firms. Whether this potential outperformance comes at the expense of Discretionary is much less important.