Stock markets’ extreme valuation gaps divide veteran investors


Two high-profile investors have offered differing strategies to deal with the dizzying valuation gap between growth stocks and beaten-up sectors: trust in bargains, or set aside traditional valuations.

So-called value stocks in sectors such as finance and energy — badly hit in the coronavirus crisis — have accelerated their recovery in the past week, buoyed by the Democratic party’s gains in Senate run-offs last week that point to enhanced government support for the US economy. Meanwhile, growth stocks, particularly in US tech, continue to break records with only minor setbacks.

But in a memo to clients on Monday, veteran distressed debt specialist Howard Marks warned that while it was “easy to be seduced” by low valuations, “investing on the basis of rote formulas and readily available fundamental, quantitative metrics should not be particularly profitable”.

The Oaktree Capital founder’s comments come days after Jeremy Grantham, co-founder of GMO, warned of a “bubble that is beginning to look like a real humdinger” in stocks. For him, one solution is to avoid big tech as much as “your career and business risk will allow” and to focus instead on emerging markets and on value stocks.

The contrasting viewpoints reflect the difficulty fund managers face in reducing dependence on a small clutch of tech stocks and hedging against the risk of a market pullback while also resisting cheap stocks whose valuations fail to keep pace.

Line chart of Rebased, % move showing Growth stocks have trumped value since the Covid crisis began

In his memo, Mr Marks said the apparent distinction between growth and value stocks is neither “essential, natural or helpful, especially in the complex world in which we find ourselves today”. Often, he said, “if something carries a low valuation, there’s probably a good reason”.

Unlike in previous decades, granular data on companies and markets are now easy to come by, making picking out overlooked bargains more of a challenge, he said. As such it “doesn’t make sense” for value investors to avoid highly-valued stocks or popular Big Tech names, he added.

Mr Grantham, meanwhile, wrote last week that he is “waiting for the last dance” in exuberant markets. “Make no mistake . . . this could very well be the most important event of your investing lives,” he said, pointing to examples of “crazy” investor behaviour.

“Value stocks have had their worst-ever relative decade [compared to growth] ending in 2019, followed by their worst ever year in 2020, with spreads between growth and value performance averaging between 20 and 30 percentage points,” he said. Emerging markets equities have similarly suffered their worst run compared with the US in about half a century.

“We believe it is in the overlap of these two ideas, value and emerging, that your relative bets should go,” he concluded.


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