Are the market moves of the last few weeks finally confirming that the long-awaited rotation from growth to value is underway?
Make no mistake – value has been a miserable place to be for the past 10 years, and it is unsurprising to see UK equity funds broadly shifting to overweight growth instead of value as a result.
Our own analysis shows that nearly 70% of the market now follows a growth style, versus just 12% for value, with the remainder made up of blended funds.
However, following some key moves in the global economy, that situation is now changing. Most notably, in the US, on 24 September, the amount investors got paid to hold three-month Treasury bills – the nearest comparison to cash – rose above the core US inflation rate for the first time in a decade.
With the Federal Reserve seemingly determined to keep raising rates and wind down quantitative easing, this seismic shift in markets is likely to grow more pronounced from here.
The market has responded to this by selling stocks that have thrived in the previous era. The classic bond proxies, such as tobaccos and other consumer staples, have been among the first to succumb, but other sectors are also showing signs of weakness.
Growth stocks – particularly those such as the Faangs (Facebook, Amazon, Apple, Netflix and Google) in the US that have powered markets higher in the last year – have endured sizeable sell-offs, while closer to home, other market darling growth names, such as Burberry, have also plunged.
So, where are the opportunities for UK income investors now? For us, rather than look to a dwindling number of bond proxies or quality growth stocks, there are instead some real opportunities among the deep value domestics.
After 10 years of outperformance from growth stocks, we feel it is unlikely that the rotation back to value will only last five days, and, therefore, it is time to focus on the companies investors have been shunning.
Two such names that have been widely shunned but which look attractive for us now are Capita and Marks & Spencer.
Taking Capita first, the business is now in the right part of its life cycle for deep value investors to look at it, following a rights issue and a number of key disposals.
On 7x earnings, it is far cheaper than the market, while its net debt levels are far more manageable than they have been.
Marks & Spencer is a different story, but it offers investors similar opportunities. Struggling for years in a tough high street environment, the key for the business is not a reversal of the prevailing economic trends, but a reversal in its dramatic underperformance versus its direct competitors.
Unlike rivals, it has only just started to reduce its store estate, despite the clear move to online shopping. So, by taking action there are some clear ways it can improve profitability.
Beware the disruptors
Of course on the face of it, most retailers look cheap now, following the severe gales that have pummelled the UK.
However, value investing has changed over the years, and while it used to be a mean reversion story, investors no longer have to simply deal with business or economic cyclicality. Now, they have to deal with disruption as well.
A very real threat, disruption has clearly had the high street in its sights for the past decade. Therefore, while many retailers look cheap compared with the historic norms, many of them have been disrupted to the point where they offer very limited upside.
The question to ask, then, is whether the businesses are in structural decline or not, and some retailers most definitely are.
While it is nigh on impossible to point to a single catalyst as a signal to change course, it is clear that we are now at a turning point in markets. Those companies that investors have relied on for income – and in many cases, they are the same ones that have funded dividends with cheap debt – are now facing an increasingly tough market environment.
Conversely, value as a style has notably begun to perform much better. While for us the true value opportunities remain narrow, as markets pull back from elevated levels, that opportunity set is only going to widen.
That is why we see such standout opportunities within the domestic UK market now, after such a prolonged focus on other parts of the market.