End of the growth bubble?Posted by Peter McGahan
Peter McGahan looks at the current exchange-traded funds and cautions history doesn’t repeat itself, but it often rhymes.
My late father gave me many tips. One that often comes to mind is: ‘when everyone starts running one way, I walk, or even step aside’.
Whilst managing money over the years, that one strategy has worked well. Goldman Sachs telling us oil would hit $200 a barrel was a sure fire sign to sell everything at $150. (Didn’t believe them).
Understanding the cynicism of financial noise is everything and takes courage to act, but for most, the conventional approach is safe because, as they say, no individual Lemming receives bad press.
It is simply not good enough to say – who would have thought? That moment after the obvious happens, when the obvious … was pretty obvious.
Quantitative easing and central bank’s interference in investments has left the investor with a small choice for where to look for a difference between the current price of an investment and a higher future price – where you will make money.
Much of that money is now concentrated in small areas especially after the Lemming style free dive into exchange-traded funds or other passive funds gathered unbelievable pace. These funds are not managed per se, and your capital is simply just spread across a range of stock like most other passive funds. The concentration in one area then becomes a bubble and that bubble is normally only a bubble when we ask what the popping noise was. Whatever, and whenever the catalyst for the pop, it was always a bubble, and no, it’s not different this time.
We can’t buy things we don’t understand and just believe the outcome will be good, and so, there are really only two things to consider: price and quality. Understand their relationship with each other and you can make money. The clever thing is to buy more quality than is reflected in the price - simple.
Investors, or your advisers, follow different strategies for investing or buying funds. Here we will deal with the big argument: Growth or Value.
Growth is buying a fund or stock where the price is likely to rise sharply, where the stocks they are invested into are involved in markets or strategies that are about to ‘come good’.
Value investing is where you invest into stocks where the price is less than its true value in the hope that the market will then spot its real value and upgrade it.
Stock prices are often calculated on P/E ratios. P is price and E is earnings. The lower the price to earnings, the more likely it’s a value stock but don’t be fooled by just looking at a low P/E ratio. It might be a Tesco … but it also might be a ‘Monarch Airlines’.
A good value manager will know where the real value is, and where the ability is to fix what needs fixing in a stock so it reaches its proper value, and, stay emotionally detached to ensure you aren’t buying a cake of bricks.
There is a reason there are few quality Value managers. I can show you any graph to prove that growth or value is best, as long as I choose my period. Growth tends to do well when interest rates fall, or are falling, and value does well at the early stages of economic recovery. There is little doubt we are in a rising interest rate environment, so be mindful of that.
What is clear however, they run in cycles, and hopping between those cycles pays well. So where are we in the cycle now? The extraordinary cycle of low interest rates has been accepted as the norm. It is not the norm, and quantitative ‘uneasing’ and rising inflation look like putting a sharp end to it.
In the past nine years, value investing has therefore had a very tough time with six months fun and 8.5 years of heartache. The total underperformance of value stocks since the financial crisis is almost twinned with that of the value stocks leading up to the mental dotcom bubble and bang. Read again.
It doesn’t look like we are at the top of the growth cycle as there isn’t enough irrational exuberance yet. We won’t know that truly until it happens.
Will the big meeting in China this week be a catalyst or a drunken 4:03 am war tweet? We can’t call that, but value is definitely value and that’s where you should look. History doesn’t repeat itself, but it often rhymes.
Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
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