Many of the attendees at this week’s Value Investing Conference in Toronto had a definite spring in their step.
It wasn’t because value stocks had achieved spectacular results over the past year. It was because they had finally succeeded in doing somewhat better than their flashier rivals.
After years of ugly performance by the value contingent of the stock market, this was close enough to qualify as success. “It’s just nice not to have to keep making apologies for value,” said one money manager at the annual conference organized by the Ben Graham Centre at Western University.
More optimistically, the past year raises hopes that value investing could finally be emerging from its long slump. Over the past decade, value investors’ fondness for cheap, dependable stocks has put them well behind more growth-oriented speculators.
The most successful investors of this period prospered by doing exactly what value investors hate. They focused on buying expensive, glamorous stocks in fast-expanding industries such as electric vehicles, e-commerce and online streaming.
Their bets on growth stocks worked in large part because of ultralow interest rates. Easy money boosted the prices of all assets. It blurred the difference between solid, financially responsible companies and highly indebted, speculative enterprises.
Until a year ago, that is. Beginning in early 2022, interest rates soared as central banks moved aggressively to stamp out inflation. The growth-at-all-costs strategy began to stumble.
Value stocks started at long last to show signs of life, with the S&P 500 Value Index outperforming the plain-vanilla S&P 500 and thumping those in the S&P 500 Growth Index.
To many value investors, the recent outperformance of their preferred strategy signals better things ahead. Bob Robotti, chief investment officer at Robotti & Company Advisors in New York, told the conference, “The financial Brigadoon is over.”
By that he means investors will no longer be able to count on unusually low interest rates to propel everything higher. Like Brigadoon, the magical village in the classic Broadway musical, the conditions under which speculative growth investing thrived are disappearing into the mist. That should create more demand for sensible, value-oriented approaches.
The world’s move away from easy money is “a big sea change,” agreed Howard Marks, co-chairman of asset manager Oaktree Capital Management in Los Angeles, and author of widely read essays on the investing scene. “A less easy period in the next five to 10 years will change what works [in investing] and what doesn’t,” he told attendees.
Mr. Marks predicted that the U.S. Federal Reserve will keep its key federal funds rate significantly higher over the next few years than the near-zero levels that have held sway for most of the past 14 years. Those higher rates are going to make for a tougher, more demanding environment.
So how should investors position themselves for this intimidating new world? That, unfortunately, is not entirely clear.
For the most part, presenters shied away from specific stock picks. One of the rare exceptions was Ratul Kapur, a partner at Scheer, Rowlett & Associates Investment Management in Toronto, who named two stocks he considered undervalued – pipeline operator AltaGas Ltd. and insurance provider Willis Towers Watson PLC.
The reluctance of other speakers to name names probably reflected the suspicion that this remains a treacherous market. While value investing has done well on a relative basis in recent months, it is still hurting on an absolute basis.
The Vanguard Canada Global Value Factor ETF, a decent representative of the value style, eked out a mere 2-per-cent return (in Canadian dollar terms) over the past year. Meanwhile, the S&P 500 Value Index lost 1.4 per cent (in U.S. dollar terms).
Better returns aren’t guaranteed any time soon. “The market is somewhat overvalued,” Mr. Marks said. “Not criminally so, but overvalued.” He would not be surprised to see the S&P 500 drop 15 to 20 per cent.
Investors who want to avoid even nastier surprises might want to keep a close eye on companies’ accounting, according to Anthony Scilipoti, president of Veritas Investment Research in Toronto.
He entertained the conference with a rundown of some of the more notable financial shenanigans he has seen as an independent accounting researcher over the past couple of decades. His list ranged from Nortel to Yellow Pages to Valeant Pharmaceuticals.
He argued that the sudden move higher in interest rates is poised to unsettle many sectors that have prospered from the steady fall in rates over the past three decades. Highly indebted companies, alternative-asset managers (“the Brookfields and Blackstones of the world”) and banks are among the businesses most likely to feel the pinch of a turn higher in borrowing costs, he said.
Value investors may want to take note. The most valuable investing decisions of the next couple of years could have more to do with what you choose to avoid than what you choose to buy.
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