Friday Morning Coffee Nr. 31: No Man's Land

091118 Friday Morning Coffee

Friday Morning Coffee Nr. 31: No Man's Land

This Wednesday, we went in Germany to meet some investors. One of the discussion topic was the potential return in favor of the value investment style. Logically, the argumentation we gave was based on rising interest rates, low valuation of value stocks against their growth peers as well as the strong earnings power of the companies we are investing in.   One of the prospects we met told us he felt European equity markets currently were in a kind of “no man’s land” between momentum strategies running out of steam and value investing not having returned to the glory it had before the financial crisis. We looked up the concept of “no man’s land” on Wikipedia and came across to the following entry: “In World War I, no man's land often ranged from several hundred yards to in some cases less than 10 yards. Heavily defended by machine guns, mortars, artillery and riflemen on both sides, it was often riddled with barbed wire and rudimentary improvised land mines, as well as corpses and wounded soldiers who were not able to make it across the sea of bullets, explosions and flames. The area was usually devastated by the warfare and riddled with craters from artillery and mortar shells, and sometimes contaminated by chemical weapons. It was open to fire from the opposing trenches and hard going generally slowed down any attempted advance. However, not only were soldiers forced to cross no man's land when advancing, and as the case might be when retreating, but after an attack the stretcher bearers would need to go out into it to bring in the wounded.”   Now, can we translate this concept into today’s stock market in Europe? As long-term investors, we are usually not commenting on short-term moves in the market. However we may currently find ourselves at an important juncture in the stock market cycle. Hence we believe it is relevant to take a closer look. The graph below summarizes the performance in Europe of value, growth, value SMID and the overall market since end of September. Source: Bloomberg, Net return indices. Data from 28/09/18 to 08/11/18. Past performance does not guarantee future results.   And yet, it appears from this chart that the observation from our prospect was fully relevant! On one side, Growth has been suffering more than any of the other strategies and has not recovered since. However, it should be stressed that, on a YTD basis, the performance of the growth investment style still has a rather comfortable advance on value. On the other side, Value has been doing better than growth and the market since the beginning of October. But again, a second look confirms that this is only true for Large Cap value stocks and not for the Small and Mid-caps segment that has been performing in line with the market. Indeed, Small and Mid-caps have generally been doing poorly recently as investors became more risk-adverse and withdraw liquidity from the market.   To come back to the analogy of the “no-man’s land” in WWI, it is also correct that we are currently seeing a lot of land mines in the stock market. Investors have till now not taken any hostages in the earnings season and have severely sanctioned the stock prices of the companies that are not meeting their quarterly numbers. We recently saw stock prices of companies like G4S and ATOS fall by 17% and 20% respectively after publishing their results. We also note there are many corpses and wounded soldiers around in the form of boutiques throwing in the towel and exiting the industry. As illustration, the London based hedge fund, Astellon, announced this week its decision to return money to clients and become a family office. According to Bloomberg, the firm explained its decision in a letter to investors with the following comment: “The market environment for fundamental and value driven investing has become increasingly difficult over the past few years”.   So, for how long will we stay in this “no-man’s land”? While it is difficult to draw any definite conclusion on the length of this period of uncertainty, we are convinced that, as value investors, we are in the right camp that will eventually win the war: fundamentally driven investment approach investing in strong companies at low valuations have historically be the winning strategy in periods of rising rates.