Since the global financial crisis of 2008, value investing has fallen out of favour. It’s easy to see why. Unprecedented technological advances have created a new breed of organisation. Initially employing a capital-light model and using emerging cloud technologies has enabled pioneering innovators to go from a garage start-up to a multi billion-dollar business in just a few short years.
Well, maybe that’s an oversimplification. But as capital continued to flow into the sector, driven by an ultra-low-interest-rate environment, so the value of growth stocks — and particularly tech stocks — has soared. In the clamour, traditional businesses seemed outdated.
Today, things are different. With the annual inflation rate rapidly heading towards 10%, value stocks are coming back into vogue. I very much see this moment as a once-in-a-generation macro-regime change where I could perhaps make strong returns. Let me elaborate.
The unravelling of big tech
Echoes of the infamous tech bubble of 2000 in today’s market are there for all to see. But if anything, the situation is worse than it was back then.
Today, three large macro themes are coalescing at once. 1) a debt-to-GDP ratio not seen since the 1940s. 2) inflation at levels last seen in the early 1980s. And 3) record valuations in US equities, reminiscent of 1929 and 2000.
In February 2021, the more speculative side of growth stocks began to unwind. But now the contagion is spreading to the mega-caps.
Just take Amazon as one example. It’s facing rising supply chain and wage costs, more intense competition and the emergence of unions that could push up staff costs. I don’t dispute that Amazon is a hugely profitable, successful company. But the problem is its valuation. Its expected future cash flow potential, the hallmark of any growth stock, can no longer justify paying a huge premium, I feel.
Inflationary bust
Inflation is the catalyst for the bursting of the bubble in US equities today. That’s a very important, and often lost, point.
In the run up to the housing crash of 2008, the oil industry, the classic value investment, had witnessed nearly a decade of rising prices. Indeed, oil hit $150 back then. When the housing bubble burst, the oil price, unsurprisingly, fell off a cliff.
Today though, we’re witnessing a total decoupling of the energy sector from every other industry, and particularly technology.
The investment thesis for energy is predicated on the capital expenditure (capex) cycle. As prices rise, oil rig count surges. Eventually, it leads to a glut of oil, prices fall and the cycle starts again.
However, today exploration budgets remain at historically low levels. In the US, aggregate capex among the top exploration and production companies is a third of what it was back in 2014 – the last time oil was over $100.
Consequently, I believe that today’s macro setup is closer to that of the 1970s than to 2000 and 2008. The 1973-74 bear market, one of the most savage in the history of the stock market, was driven by runaway inflation and a commodity shockwave.
Indeed, throughout the 1970s there were only three classes of assets that outperformed the market – energy, gold and silver. That is why a large part of my portfolio is now assigned to companies including BP, Shell, Fresnillo, Glencore and Newmont. These are the new FAANGs!