Value stocks are likely to have a short-term rally as the coronavirus crisis begins to ease but Columbia Threadneedle’s Neil Robson believes quality-growth is the only standout opportunity for the longer term.
The past decade or so has been characterised by the strong performance of quality-growth stocks, which benefitted from massive quantitative easing programmes in the wake of the financial crisis and a low-growth environment.
Value stocks, on the other hand, have lagged significantly – as the chart below makes clear.
Performance of investment styles over 10yrs
Source: FE Analytics
The performance gap between the value and quality-growth investment styles had become so stark that many argue the reversal of this trend will be a once-in-a-lifetime opportunity.
However, this argument has been made for several years without bearing fruit and Robson – head of global equities at Columbia Threadneedle Investments – doesn’t expect the coronavirus crisis to be catalyst that causes value to outperform over the long term.
“In today’s fast-moving environment it is worth recalling that the virus will not dominate headlines for ever and equity markets will rebound once they foresee evidence of the global economy recovering,” he said.
“The initial winners may well be value stocks. But in the longer term, buying high-quality companies at around two-thirds their pre-crisis prices cannot be the wrong thing to do.”
Robson conceded that traditional business cycle analysis techniques have no inputs for a global pandemic, leaving them with little insight into how portfolios should be positioned.
However, he argued that “one opportunity stands out” to him and that is the fact that many high-quality growth companies now look much cheaper than the levels they were trading at in the early-2020 highs.
As noted, quality and growth have enjoyed a strong run in the post-financial crisis environment but are down around 10 per cent since the market’s peak on 19 February – and that is after a recent rally.
Performance of quality and growth since 19 February peak
Source: FE Analytics
Robson expects to see quality-growth stocks benefit from many of the factors that caused their outperformance in the bull market that followed the financial crisis.
“In a post-Covid-19 low-growth world, these same companies are likely to continue to prosper,” he explained.
“With formidable economic moats, or competitive advantages, they are the beneficiaries of secular trends such as the rise of cloud computing, the expansion of capital-light knowledge-driven businesses, and ageing populations.
“The virus might have brought economic activity to a halt for now, but these powerful trends will continue almost regardless.”
He gave Mastercard as an example of a high-quality stalwart that looks positioned to benefit over the long term but has been hit hard in the coronavirus sell-off.
Since the crisis started, analysts have lowered their estimates of Mastercard’s future earnings by more than 10 per cent while its share price dropped by about one-third between mid-February and the end of March. “It is rare to have a chance to buy such a winning company at 25-30 per cent below its previous valuation,” the manager added.
However, Robson was keen to point out that quality-growth stocks will not always outperform value. Indeed, he noted that there were at least five periods in the post-financial crisis bull run when value stocks outpaced growth and quality by a wide margin.
“When equity markets initially rebound from the current crisis, it’s likely [value] will once again rise further and faster,” he said.
“Governments and central banks have injected a huge amount of fiscal and monetary stimulus, and there will be pent-up demand, so the first burst of economic recovery may be strong. As is often the case at such times, value stocks – many of them low-quality with financial and operating leverage – will likely perform best for a short while.”
That said, Robson thinks quality-growth will return to the fore when the economic recovery – be it V-shaped, W-shaped or U-shaped – emerges and investors realise that there is another “long grind of slow growth” ahead of them.
“This post-recovery environment could be a case of déjà vu, similar to the 12 years that followed the global financial crisis. As economic growth remained subdued, interest rates stayed low and capital was inexpensive,” he finished.
“The result? The number of companies able to generate reasonably high earnings growth year after year shrunk. Broadly speaking, only high-quality growth companies could do so and their stocks outperformed.”