Sifting Value From The Rubble

By Eli M. Salzmann

The era of cheap money and low inflation is over. We see an opportune time for active equity managers to shine.

Even great parties – like the recent 14-year equity bull run – must come to an end.

We believe the recent correction is more than just another crank of the economic cycle. After years of negligible inflation and rock-bottom, real interest rates sent equity valuations to frothy heights, investors now need to adapt to a more challenging landscape of slower growth, modest returns – and perhaps more near-term pain. But major downturns can also present attractive opportunities for thoughtful, long-term investors.

Here is some food for thought when sifting for value amongst the rubble:

Not all earnings are created equal. We find the gap between companies’ reported income and their actual cash earnings to be as large as it’s ever been. That disconnect could favor skilled active investors seeking intrinsic-value opportunities.

More pain for technology stocks. Tech has generally underperformed most sectors since November 2021. Nearly all of that, we believe, was due to rising real yields (and thus rising risk premia), but now the effects of the softening economy are starting to show and many people are realizing these companies are more cyclical than they imagined. We believe earnings and P/E multiples could potentially come down further over the next 6-to-12 months.

Beware growth disguised as value. The definitions of growth and value have shifted during the last expansion. A handful of companies that have performed well now appear to dominate the market-cap-weighted S&P 500 Index as of September 30, 2022, making it look more like a growth benchmark than a core benchmark – potentially masking overall risk in portfolios.

Think regionally. The world is changing at different rates in different places. (For example, while many developed countries have pursued tighter monetary policies to stem inflation, Japan has not.) Minding those regional nuances could present an attractive return profile.

Great companies aren’t always great stocks. Many dominant industry players aren’t going away anytime soon; at this point in the cycle, however, we think large-cap-growth assets could potentially underperform large-cap value over the next 5-to-7 years.

Stay disciplined. Fourteen years into a bull run, we noticed that some investors abandoned their bias toward value. In our view, it would be the worst of all possible sins to underperform on the way up and not be in the market at a point in the cycle when value is poised to do well. Our advice: stay disciplined.

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