The year 2016 marked the first year since the Global Financial Crisis (GFC) of 2008-09 when value investing decisively beat growth investing as a category, with value-style returns exceeding growth style returns by roughly 10 percentage points in most capitalization categories last year. Value stock indices are heavily populated by financial companies, which tend to be very sensitive to interest rate trends. Unsurprisingly, financials, bond yields, and value stocks as a category leapt forward in sync following U.S. elections, and subsequently lagged in relative performance terms when the upward momentum in bond yields topped out in early January, perhaps reassessing how much real change can be wrought.
Whether or not value stocks truly “over-performed” in late 2016 or just needed to consolidate gains remains to be seen, but the change in market conditions in the first quarter suggests at least one of these narratives is true. Right around the Trump inauguration in January, market conditions flipped, and big cap growth stocks (which had lagged in late 2016) went on a tear while value names did little. The flip back from value to growth was most pronounced in small caps (growth benchmarks up over 5%, value indices down fractionally); that said, growth issues outpaced their value counterparts by a factor of 1.5x to 2.0x in most broader indexes.
Growth or Natural Monopolies?
Looking beyond the rate-trades and the correlation of value sectors to a (plausible or implausible) acceleration in nominal GDP growth, there is a larger question raised by both the revivalist spirit in recent populist politics and the brief revival of value stocks in general. Are either really achievable or just wistful thinking? Or is there an alternative narrative that is independent of the whole interest rate discussion: gigantic technology-led monopolies drawing profits from adjacent spaces into their own, gradually blotting out normal business coping mechanisms.
With supercap technology stocks dominating the stock market in 2017, the question worth asking is who or what can stop these guys? And how? It has happened before. At their respective peaks in a distant past, Eastman Kodak, Xerox, and IBM were thought to be similarly unassailable in their product categories (film, photocopiers, and mainframe computers, respectively). It’s not that anyone ever came along and made distinctly better film or mainframes, but the use case for their technology declined and the companies became much less relevant. At varying points in the less distant past, Apple was nearly vanquished by Microsoft-powered PCs only to reinvent whole new categories that it now dominates. Microsoft later faced questions of long-term relevance owing to its dependence on a traditional software model geared to desktop PCs, but its remaining server and office product suite have potentially broader audiences in a cloud-based model of computing. Even more recently, supercap technology businesses of the early 2000s such as Intel and Cisco have shown limited capacities to grow outside their monopolistic positions in microprocessors and routers this decade. This has led to low-ish valuations that embed a “fade” of their dominance as end market demands move away from their core strengths.
Hence it is not inconceivable that today’s technology giants could face alternative forms of competition, or encounter a core market structure shift that they are not able to cope with very well. But for the time being, such prospects seem difficult to identify. With internet-based ecosystems leaping to the fore, companies that control the on-ramps to the internet (Apple devices, Google search & related devices), integrated online ecosystems (Facebook, Microsoft Office), and the ultimate ecommerce superstore (Amazon) have become the most valuable companies in the global stock market.
From the value lens, one hopes to prosper from the normalization game. That would be sensible in a more traditional industrial/ competitive landscape. Does the following statement hold water? As __________ (name your preferred technology super cap stock) pushes deeper into ___________ marketplace, the entrenched competition __________ will adjust their resources and products and preserve much of their profitability, and potentially grow as their rate of innovation is forcibly upgraded.
Download Cambiar Investors' complete commentary, or read JP Morgan's 2nd Quarter 2017 Guide to Markets.
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