Allison Nathan, a senior strategist at Goldman Sachs, interviewed experts both internal and outside of the company to discuss whether the continuing bear market in U.S. stocks represents a major paradigm shift for investors. For Cliff Asness, founder and chief investment officer at Connecticut-based AQR Capital, the answer is a resounding yes.
For Mr. Asness (who is also a former director of quantitative strategy at Goldman Sachs), the previous investing era was characterized by low and falling interest rates and growth stock outperformance. He believes we are now embarking on a prolonged period of value stock outperformance.
The fund manager believes that growth stocks earned their outperformance over value stocks in the 2010-17 period, with prices in line with strong growth fundamentals. From 2018 to 2020, however, the growth rally went “way too far.”
The end result is that relative to growth stocks, value stocks have not been this attractively valued since the excesses of the late 1990s technology bubble. Mr. Asness estimates that value stocks are trading at levels nearly as attractive (95th percentile) as growth stocks historically, and almost as cheaply priced as during the technology bubble peak.
AQR is confident that value investing strategies will outperform over the next three years, as relative valuations return to normalized levels.
Another interviewee, Goldman Sachs chief U.S. equity strategist David Kostin, gave an equally definitive answer to the new paradigm question, only this time in the negative. “No, I don’t see a paradigm shift in the fundamental drivers of the equity market,” he said, “but rather a wholesale shift in the interest rate environment, which has important implications for equities.”
Mr. Kostin noted that, as recently as September, 2021, the futures market discounted only one Federal Reserve rate hike of 25 basis points. Now, a total of 350 basis points of hikes are expected.
The strategist emphasized that when interest rates were close to zero, the cost of capital for investors and companies was extremely low. In this environment, investors favoured companies with the strongest potential growth over those generating cash flow. Valuations for these stocks soared in the 2018-20 period, as Mr. Asness noted, although Mr. Kostin calculates that speculative companies are now trading with lower valuation levels than before the pandemic.
Mr. Kostin believes that investors should position their portfolios according to the economic outlook. His view is U.S.-centric but does provide strategic hints for domestic investors.
Goldman’s economists see a one-third probability for a U.S. recession in the next 24 months. As a result, investors should allocate 33 per cent of their portfolio in “margin of safety” stocks that would still be attractively valued if their earnings fell 20 per cent.
For the remaining two-thirds of U.S. portfolios, the strategist recommends a combination of higher-growth stocks where management is likely to repurchase shares at current lower levels, and also dividend-paying stocks. Mr. Kostin expects significant dividend growth for the S&P 500 in the next three years.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: I went to cash just before the pandemic (good) but then stayed out during the market’s big climb (bad). I started buying again last fall and am now two-thirds fully invested in high-quality dividend stocks. Here’s my question: When I buy a stock, should I be paying more attention to the stop-loss function? If so, what guidelines do you suggest?
Answer: That’s the thing about selling when stuff hits the fan: You might spare yourself some losses on the way down, but it takes an iron stomach to get back in. Most people wait until they see clear signs that the crisis is ending, by which time prices have already recovered. I probably don’t need to remind – but I will anyway – that holding great companies through good times and bad is a tried-and-true recipe for investing success.
Which brings us to your question about stop-loss orders. When you place a stop-loss order, you are instructing your broker to sell the stock when the market price drops to a certain level. Unless you specify otherwise, the stop-loss order then converts to a market order, meaning the broker will sell the shares at the best available price.
-- Read John Heinzl’s full response here.
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Compiled by Globe Investor Staff