Value ended Q1 as the dominant factor driving equities, rounding out three straight quarters of going from ‘worst to first’ in performance attribution, in the words of analyst Style Research.
The reflation trade underlying the phenomena was looking increasingly shaky throughout March however, as investors began to question the ability of the Trump administration to pull off the business-friendly bits of its agenda.
With much of the low hanging fruit already harvested, equity owners are increasingly exposed to any reversal. So how should managers ensure they do not overreach and tumble into value traps?
‘After the financial crisis, there was a massive bounce in value stocks, the oil companies and steel companies for example. All the rubbish basically had a massive bounce and then for the next three years quality did well again. I think that now we are in the same situation.’
He suggested that the western world’s failure to address its leverage in the intervening years means that many businesses are still vulnerable to unpredictably switching between despair and euphoria.
He said: ‘I don’t believe that the West is going to enter a fast growth anytime soon.’
Mayo adds that experiments with monetary policy may have actually spread the problem to other regions.
‘Today, for me, the biggest concern for commodities is China. China is on a glide path to a lower rate of growth of maybe 5% longer term. So I think commodities have had their day. People who are chasing commodities are going to be in value traps.’
A divided China
Mayo is not the only one concerned about being suckered by putative value in equities dependent on the sputtering Chinese engine of regional growth. Matthew Vaight, manager of the M&G Global Emerging Markets fund, agrees that those hoping for catalysts to rerating may be disappointed.
‘The Chinese economy is widely considered to be divided into two sectors – the “old” economy based primarily on low-cost manufacturing and infrastructure capex and the “new” economy focusing on tertiary industries, consumption and the internet,’ Vaight said.
Currently the old economy can be characterised as suffering from excess capacity, low profitability and debt. The new economy, on the other hand, is seen as innovative and growing rapidly.
‘The stock market today is largely divided along these economic lines; companies exposed to the old economy are out of favour and on the face of it look cheaply valued.’
Vaight highlights that the old economy companies have the potential to be value traps if the sentiment towards China’s manufacturing and infrastructure remains the same.
However, he says he is prepared to take risk on some sub-sectors and highlighted packaging companies and plastic piping manufacturers as niche areas that he thinks are fundamentally mispriced.
Beware the UK
‘As a team, we have always got to be asking ourselves is it value or is it a value trap? The biggest area of concern now is the UK consumer. We see areas of terrific value within UK leisure and UK retail.
‘There are value stocks that are so much cheaper now than they have been for decades. But at the same time, look at the challenges facing those sectors. What happens if interest rates start going up or we do not see wage growth, and the minimum wage is a cost measure coming through? All of these things are coming together when we look at these businesses to see if they are value traps.’
He added the sector is also likely to face headwinds as the UK withdraws from the EU.