Jamie Clark

Has the move to ‘value’ started?

Jamie Clark

This summer, I wrote several blogs outlining the outlook for the Macro-Thematic funds in terms of liquidity, valuation and dividend yield. The second of these blogs concentrated on valuation and flagged the record difference between the ratings of the market’s most expensive and cheapest companies. I explained that the superior long-term returns accruing to ‘value’ stocks, meant that we saw opportunity in this anomaly and had seized it by increasing our weighting to cheaply-rated UK life insurers, banks, miners and oil majors.


The third blog developed this argument in addressing dividend yield. We established the predictive value of yield as an investment factor and assessed the yield merits of UK large-caps; citing both in support of our call to increase exposure to the FTSE’s abundance of cheap income stocks.


Have events made us look like Liverpool FC, or Stevenage FC? Bluntly, July and August felt more League Two than Champions League. Macroeconomic data sagged, yields plummeted and investors bid up ‘quality’ and ‘growth’ companies; businesses with compound or accelerating earnings growth that some suggest offer refuge from the vagaries of the economic cycle. At the same time, cyclical and mature value companies, precisely the kind of shares we own on grounds of valuation and yield, were under the cosh.


To paraphrase Earth Wind and Fire, however, do you remember September? It remains indelible in our minds because it feels like a market watershed. September witnessed a fundamental realignment of equities that some have christened a ‘momentum’ crash[1]. Now, momentum as an investment factor is a cypher, in that it simply means those stocks that have performed best over a defined period. In this instance, however, it refers explicitly to the quality and growth businesses that thrived over the summer and that have held sway in the low-rate post-financial crisis era.


What did the momentum crash entail? September saw a sharp rotation out of momentum stocks and into the kind of value companies that populate our portfolios. Whilst equity indices barely budged overall, there was a staggering dispersion between the performance of value and quality/growth stocks. 


The below chart uses FTSE All Share data to illustrate this difference according to the cheapest and most expensive quartiles of four investment factors: price-earnings (p/e), price-to-book (p/b), price-to-cashflow (p/cf) and dividend yield. We focus here on the 9th and 10th of September, the sharpest period of the momentum crash.


Has the move to ‘value’ started?

The effect is even more apparent if we concentrate on UK large-caps.


Has the move to ‘value’ started? 

Talk of factors can seem abstract. But we can animate the point by couching things in terms of sectors and companies. The UK’s worst performing sectors had a quality/growth skew, consisting of personal goods businesses, distillers and software companies. Understandably, the FTSE 100’s weakest individual constituents had a similar bias; the five worst performers (Just Eat, Aveva, London Stock Exchange, Sage and Experian) trading on a startling average of 35x historic earnings!


Contrastingly, the winners had an obvious value tilt. Life insurers, banks and oil majors were to the fore. The FTSE’s standout performers were cheaply-rated dividend payers like Aviva, Barclays, and Legal & General. These are companies we own, with attractive valuations and dividend yields forming a big part of their respective merits.


But what triggered this and what are the implications? Some have cited September’s modest increase in risk free rates, or US-China trade talk news. But this smacks of what Nassim Taleb termed narrative fallacy; our need to explain events in terms of linear cause and effect relationships, where none may exist. More likely, this is an unavoidable correction to the yawning gap between the valuation of cheap and expensive stocks and the resultant crowding amongst growth and quality businesses. Whilst the timing of such episodes is always moot, the underlying conditions typically exist in plain sight and investors are often gifted an asymmetric trade-off between risk and reward. Our value bias aims to exploit this skew, as we believe it limits downside relative to prospective gains.


To date, October returns have offered confirmation. The funds’ Brexit-impacted, UK-centric holdings have outperformed as ‘no deal’ risk has receded and settlement looms. Whilst the detail of any Brexit agreement is important, what matters more, at least from a portfolio vantage, is the fact of the agreement and the degree to which it influences market positioning. This has prompted a sharp adjustment to the decade-long divergence between UK value and growth companies; a divergence exaggerated by three years of Brexit unknowns.


UK value has been in the ascendant, markedly so in the second week of October. As per the momentum crash, FTSE All-Share and FTSE 100 data during this period makes this clear.


Has the move to ‘value’ started?


Has the move to ‘value’ started?

Reverting to English from Vulcan, this has been bad news for companies like RELX, Diageo and Compass Group. These typify the UK’s quality/growth cohort, which has re-rated since 2016 as investors have coveted less cyclical, non-sterling earnings. We have zero exposure to these businesses on grounds of yield and valuation.

At the same time, recent fund returns have benefited from the markets’ renewed appetite for companies like Lloyds, Legal General, BT and Barclays. These are attractive income plays, trading on discounted ratings largely by dint of the market’s post-crisis stylistic preference.


Whilst the narrative differs, the events of September and October are substantively similar. The extreme valuation gap between value and growth companies, along with associated investor crowding, should leave buyers of growth prone to further painful drawdowns. Equally, historically cheap value companies are offering us unprecedented buying opportunities. This gives us great confidence in our value positioning.


[1] FTDrop in hot stocks stirs memories of “quant quake”, 12/9/19

For a comprehensive list of common financial words and terms, see our glossary here.

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Friday, October 25, 2019, 12:55 PM