Sebastian Lyon has warned there are real signs that investors could be about to make the biggest mistake of all.
In his latest investment update, the Trojan fund manager expressed deep concern for investors' continued demand for growth stocks.
The burgeoning demand has left Lyon's well-honed 'value' approach struggling to keep up over the short term.
In the 12 months to the end July, the £4.1 billion Trojan fund has returned just 0.5% versus an Absolute Return sector average of 2.4%.
Over three years it remains comfortably ahead of the peer group however, delivering 19.5% against an 11.2% average.
Lyon is sceptical about the seemingly insatiable appetite for growth following a 'golden era' for the style as investors struggled with a near-decade of secular stagnation and ultra-low rates.
'Performance has been driven by impressive earnings gains combined with material re-ratings,' he said.
'Much to the frustration of self-described value investors, earnings growth during this cycle has been more narrowly concentrated in expensively priced stocks, whilst those on lower multiples of earnings have generally not benefited from any improvement in their fundamentals.'
Lyon pointed out that the best returns 'are almost always' found when so-called growth is priced cheaply. He noted that chasing growth at any price can be equally as damaging as purchasing businesses with weak fundamentals.
'Extrapolating and overpaying for recent growth, even if this proves sustainable, is often the most expensive investment mistake of all,' Lyon warned.
'Sometimes even the soundest and most dependable growth can be overpriced, and even the best companies can sell on too high a multiple.
'When valuations are excessive investment evolves into speculation. To some extent, this is where we are today. For prudent investors, this should be a warning signal.'
Faangs for the memories
The Faangs (Facebook, Amazon, Apple, Netflix and Google) have become emblematic of investor's willingness to aggressively bid up any sign of material earnings growth
Lyon does not believe the acronym is helpful to investors, saying that pigeon-holing these stocks is mis-leading as they inevitably follow different trajectories.
'This is a simplistic grouping of technology stocks, the usefulness of which may have already peaked,' Lyon said.
'It is certainly descriptive of the narrow leadership we have witnessed in stock markets of late. Such concentration tends to occur close to the peak of a market cycle; excluding the Faangs, the S&P 500's first-half returns would have been negative.
Diminishing turnaround opportunities
Lyon is generally finding it harder to find turnaround opportunities in today's market conditions.
'Successful turnarounds are few and far between in today's market, where an increasing number of businesses are struggling to remain relevant,' he said.
'One only has to look at recent experiences in the outsourcing or retail sectors to see the challenges of corporate restructuring.'
This has presented a challenge for Lyon's approach. However, he remains circumspect when it comes to 'bottom-fishing' as he chooses to focus heavily on companies with attractive returns on capital, financial strength and earnings growth.
'There are many companies that we would not buy at any price, however cheap they appear,' Lyon said.
'Avoiding the dross is more than half the battle when it comes to investment survival. While there may be plenty of superficially tempting opportunities in the stock market, we prefer to remain more discerning.'
With asset prices inflated across the board, Lyon warns there are fewer places to hide than in previous cycles.
'It has been so long since an economic downturn that the probability of a recession is being all but ignored,' he said.
'Good times do not last forever and the extrapolation of current earnings growth may a mistake the market must re-learn.'
While Lyon does not single out a particular potential catalyst for a turn in sentiment, he suggests the tightening in US rates for the first time in decade could be 'all it will take'.
When this sentiment shift occurs, Lyon is optimistic his conservative approach will deliver.
'Conservative active fund managers tend to outperform in failing markets. Rather than panicking when markets turn down, we have the liquidity and the wherewithal to allocate to riskier assets at improving valuations,'
'While the focus may be on relative performance today, savers will return to absolute values in the future. They always do.'