Market gyrations since the pandemic began have been incredibly propitious for tech stocks, boosting the tech heavy NASDAQ Composite Index, which is up roughly 32% YoY . An almost ‘safety trade’ approach – that of long tech (particularly FAANG stocks) – has emerged as a popular trade amongst investors, having been underweight on more economically-sensitive industries such as Oil & Gas, Airlines and Retail. Despite this, recent news of vaccine trial success for both Pfizer and BioNTech, as well as Moderna, has seen the market adjust and rotate from growth stocks to value stocks. As mentioned by FT writer Robin Wigglesworth, November 9th was the biggest one-day rise in the value factor since data collection began; conversely, it was the worst one-day performance for momentum stocks, falling by around 14% . Although it’s important to not conflate the value factor with value investing; as well as avoiding an equivalence of momentum and growth, such market moves have been symptomatic of a change in tac for investors, who now hold as little cash now as before the pandemic.
Growth vs Value defined
Growth stocks are expected to grow their financials at a significantly fast pace, as shown by the increasing sales of several FAANG stocks since the pandemic began. Characteristically, Price to Earnings ratios of growth stocks are typically rather high and their prices are intrinsically more volatile due to the expectant nature of profit growth. Typical examples would be the FAANG stocks, as well as TSLA, whose P/E ratio currently stands at 489 – an astronomically high premium which investors are paying.
Value investing is predicated around finding firms which have strong underlying fundamentals, such as strong relative cash flows and balance sheets. Trading at lower P/E ratios, these firms are seen as undervalued by the market – investors look to profit when the market interprets the intrinsic value of these firms and their share prices begin to rise. Operating in more economically-sensitive sectors, value stocks have been overshadowed by their growth rivals since the inception of the internet and even after the dotcom bubble at the beginning of the millennium. Most recently, the value factor was said to be at its lowest since the death of Thomas Edison – that was in 1931. That has hurt value investors such as Warren Buffett, who is the pupil of the author of The Intelligent Investor, a certain Benjamin Graham.
Fixed income and inflationary implications
Fixed income assets, most predominantly Treasuries and Gilts, are also good indicators of changes in the growth and value investing. From a cash flow perspective, growth stocks tend to have little to no cash flow; whilst value stocks have positive stable cash flows. So given analysis of a firm via a Discounted Cash Flow model, changes in the risk-free rate can have consequences on the weighted average cost of capital, in turn changing the value of the firm with a given cash flow(s). As growth companies have lower levels of cash flows, they are more adversely affected with a rise in the risk-free rate. The bellwether of risk-free rates is most likely the 10-year US Treasury, its yield falling during the Fed’s largesse during the first part of the year (below):
A fair proportion of the accelerated excess returns in tech could be attributed to the fall in nominal yields across the yield curve (the fall in 10-year rates is not idiosyncratic), with the Fed buying Bills, Treasuries, loans and other credit-related instruments in unprecedented levels via a plethora of schemes .
But with the recent announcement on a potential vaccine rollout in the next few months – and a subsequent return to “economic normality” – in conjunction with the new “average inflation targeting” of the Fed, the reflation trade has been mooted in recent weeks. If inflation is allowed to rise above typical/past target levels, rates could rise, signaling a more adverse effect on growth. Given macro performances are expected to improve as we recover from the virus, value firms are also expected to deliver better fundamentals as we reach the latter end of 2021.
Despite this, dovish sentiment is likely to continue for the foreseeable future, quashing the prospect of rising rates. Additionally, central banks could follow the Bank of Japan in a pursuit of yield curve control to keep borrowing costs lower for longer. Threadneede Street has also considered the introduction of negative interest rates . Such a move would rule out a switch to value from a rates perspective. Investors should rely on a more revenue-based perspective derived from a broader cyclical economic environment.
Why Growth could still outperform
Growth – and specifically Tech – is still likely to outperform the market over the next twelve months given incredibly strong revenue growth and cash levels. Although Tech itself can be seen as a “Growth” industry, the FAANG stocks are cash-rich and have recorded record revenues throughout the pandemic as their operations and products thrived in the work-from-home environment. Given the fact that Growth is predominantly Tech – and the FAANG stocks constitute a large part of the Tech sector itself – it could be likely that there is still rationale for bullish sentiment for Growth as a whole over the next twelve months.
|Firm||Annual free cash flow as last reported ($, mn)|
Value vs Growth over the next twelve months
From a macroeconomic perspective, improving PMIs, growth and sales figures should all translate into improving fundamentals for firms seen as value picks. With the number of potential vaccines increasing after the Oxford-AstraZeneca results release on Monday, rollout is imminent. Despite a delay in complete vaccination against the virus, this will still result in increased consumer confidence and investor optimism. Additionally, Growth – as seen via the Tech effect – should also be boosted, reflecting a broader rise in equities. Given that value firms have not recovered to pre-pandemic levels, the growth of value is perhaps expected to be larger than that of growth itself – but there is ample reason to be bullish on both as we enter a post-pandemic world.