Dear Fellow Investors and Friends
If you’re new here, welcome! And welcome to everyone else, of course. I do appreciate you taking the time to read this.
Today is the 320th day of the year; 45 days remain until the end of the year. Only six weekends are left before Christmas, so make the most of them.
On this day in 1867, Edward Callahan unveiled the first stock ticker, devised for the Gold and Stock Telegraph Company in New York. The advent of the ticker ultimately revolutionised the stock market by making up-to-the-minute prices available to investors around the country. Now, share traders could track how much money they were losing in real-time. It still didn’t stop them from trying.
And 166 years later, they are still trying.
The winners? As always, the croupiers, or, as they are known in financial circles, stock exchanges.
Quotes of the day
“And those who were seen dancing were thought insane by those who could not hear the music.”
All investors want one thing – to grow their capital satisfactorily over time. How they go about doing so can follow different paths, though. Some investors only buy what they regard as high-quality assets and hold them for the long term; others buy distressed assets and sell them when they improve, otherwise known as turnround investing; and others buy what is going up and sell what is going down, otherwise known as momentum investing.
These are not the only ways; there are many others – some less rational than others. But none of them are wrong, per se.
However, there are two rules to follow. You have to
- Choose a philosophy that resonates with your personality
- Stick to your chosen philosophy consistently. And you won’t if you didn’t follow rule #1.
My investment philosophy is that of value. Ben Graham – the father of value investing – defined it as follows:
“Value investing is an investment operation that promises the safety of principal and a satisfactory return. All other operations are regarded as speculation.”
That resonates with me, and I have been applying it to my investment operations for many years now. Sometimes successfully, other times less so. However, I have always been consistent in applying the value approach.
The perception is that Value as an investment strategy has been underperforming for a long time. And it has indeed struggled since the global financial crisis of 2008 – 15 years ago!
Despite this, I have been on record as saying – since 2021 – that the trend is changing, and value is coming back into fashion.
And I have been wrong when you look at the US market:
This has been driven by “The Magnificent 7” or Amazon, Meta, Alphabet, Netflix, Tesla, Microsoft and Nvidia:
So, what’s going on?
One theory is that interest rates are important to the performance of large-cap growth stocks. After all, or so the theory goes, their big cash flows lie far in the future due to their high growth profile. The lower interest rates are, the more valuable the present value of those cash flows. Hence, when the market expects interest rates to decline, growth stocks should outperform value stocks, which is exactly what has happened this year in America.
However, I think Cliff Asness’ (from quant shop AQR) argument bears thinking about, which he made in the paper “Is value just an interest rate bet?”
His conclusion: not even close.
His argument is that growth stocks’ duration – i.e. the average time to receipt of all cash flows – is not much higher than value stocks (duration is a measure of sensitivity to interest rates – the higher your duration, the more sensitive you are to the movement of interest rates).
How is this possible, as AQR’s quantitative work shows that growth stocks have a 4% p.a. growth advantage over value stocks over five years? It’s because most of that excess growth happens in the first two years, so it doesn’t impact the duration calculation much. In the paper, Asness calculates that growth stocks have only a 0,4 years duration advantage over value stocks.
Asness says, “It is not the level of earnings that affects duration; it is the time shape, and the only way to affect the time shape enough to move duration seriously is to make assumptions of large and extremely long-lasting (way more than 5+ years out) growth differentials that historically do not exist” (emphasis added).
Growth vs value is correlated with the interest rate cycle because investors think most growth stocks are unicorns i.e. super high growers for a very long time. Such stocks would indeed have a high duration.
The problem, as I pointed out in Vol 1 No. 11 last week, is that really big winners like Amazon and Google are very few and far between. Unicorns don’t even exist in stock markets, as much as we wish them to. A bubble is defined as asset prices discounting an unrealistic growth profile, which neatly describes significant parts of the US stock market. In other words, bubble valuations cause interest rate correlations. But this is only temporary; the work of Jeremy Grantham of GMO fame has shown that all bubbles end.
Some corroboration for this view can be gleaned from other markets where value is doing well:
The one geography that is missing in the above chart is South Africa. Fortunately, I have the data on the only true South African value fund, the SCI Merchant West Investments Value Fund. If you are aware of any other – i.e. that invests only in South Africa and is not constrained by size, let me know!
Of course, I have the data because I co-manage this fund with my colleague Brian Pyle. And over the past three years, it has also outperformed the average general equity fund and the All Share Index:
So, the USA is the only market where value is not doing well. And it happens to be the only market where AI dominates corporate communication. Or the only market driven by magical AI bubble thinking, whichever is your preferred nomenclature for some very interesting valuations, specifically of the magnificent 7.
So, despite the perception of value being dead and buried, it seems alive and kicking.
This begs the question: can you hear the music yet?