October 2020 / OUTLOOK
Managing the Bifurcated Returns Between Growth and Value Stocks
Global Equity Quarterly Outlook Q3 2020
- Growth stocks showed market leadership before and throughout the coronavirus crisis, supported by greatly superior sales, earnings, and cashflow characteristics.
- We have reduced positions in many of the outright winners from the coronavirus pandemic, specifically where we felt valuations had expanded to create risk.
- In many cases, we reinvested proceeds into high-quality, product- and innovation-driven cyclicals, where we identified stock-specific drivers of accelerating economic returns.
Global equities faced downward pressure in the third quarter of 2020, but we do not believe that implies the bursting of an equity or, specifically, a growth equity bubble. Earlier in the year, the market began to recognize what we had already been positioning the portfolio for early in the crisis—that certain companies would see their economic futures pulled forward by the coronavirus pandemic. These were mainly in the growth area of the opportunity set and led to the unusual outcome that growth showed market leadership before and throughout the coronavirus crisis, supported by greatly superior sales, earnings, and cashflow characteristics.
Several factors have driven the significantly bifurcated returns we have seen between growth and value stocks. Central is that capacity continues to be unlocked, fueled by monetary stimulus, and enabled by a new era of technology.
Challenges posed by narrow market leadership
Massive stimulus and the "stop getting worse" phase of the health crisis have encouraged flows into risk assets, especially certain growth stocks. The direction of the flows has been enhanced by the growth of passive investing and has dovetailed with the most extreme index concentration seen in U.S. equities since 1999, as well as factor-driven investing focused on "momentum" and "growth" characteristics. This is unhelpful in terms of market breadth and for fundamental investors in many senses, but it's a backdrop we've seen and managed through before.
Reducing positions in many of the outright winners
In our view, broad-based valuations are not extreme, but certain areas in the mid-cap and smaller large-cap spectrum do look expensive. While there are good reasons underlying multiple expansion since equity markets troughed in late March, we have been very conscious of the need to manage the valuation element of the risk equation, and have reduced positions in many of the outright winners from the coronavirus pandemic, specifically where we felt valuations had expanded to create risk. In many cases, we reinvested proceeds into high-quality, product- and innovation-driven cyclicals, where we identified stock-specific drivers of accelerating economic returns.
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