Monday, February 22, 2021

Value vs Growth

The most important investing theme in the world today is the potential reversion to long term trend of value vs growth (VvG).

The covid case numbers are crashing and it appears as though herd immunity (through a combination of vaccines and previous infection) has been reached. The catalyst for the VvG inflection will be the economy reopening combined with shortages stemming from a year of lockdown socialism and the printing of $3.4 trillion in a year. 

The pent up demand for many types of goods and services is so high that we could see a one-time price spike, almost like a currency devaluation, that benefits old-economy goods producing companies and ends the bubble in the Robinhood fad stocks.

I was sitting with the bartenders and managers at my local joint after they closed and for the first time ever they started talking about investments. Some things mentioned: marijuana stocks, BYND, sub-penny stocks, TSLA. All based on momentum. General manager mentioned one of the bartenders made $20k on a sub penny stock and was giving him Apple trading advice. He's at risk for these kinds of employees suddenly quitting when that kind of money falls in their lap.

Another recent anecdote is talking with an early 20s zoomer who is trading Dogecoin on Robinhood. He calls the coins "shares" since the Robinhood UI apparently doesn't distinguish between a crypto coin and an equity share.

These retail folks don't have any self-awareness or irony about what they're doing. It's like how crazy people never think they are crazy; these guys never say "I'm going to put a little money in a momentum strategy and continually rebalance and take profits if it works". If anything, they add capital as the prices go up.

But even though I think the inflection point is here, it does not have to be for value to be a great trade with a cheap hedge. I don't have to call the inflection point or bubble top. I can buy the bottom decile cheap stuff and hedge it with long term put options on the top percentile expensive stuff. 

The reason I think that works is that with record valuation dispersion between value and growth, the top percentile is overvalued by 10-100x. The puts are "expensive" on IV but these represent trillions of dollars of market cap that may vanish in 24 months. Examples: TSLA, ZM, SPCE, NKLA, LI, XPEV, CVNA. Then there are garden variety expensive stocks like CMG, but the IVs on those are cheaper so they could work too.

Meanwhile, the cheap part of the market looks like tobacco (1,2), hydrocarbons, land/timber, pipelines, certain Oddballs, and small banks. All real assets except the banks, but I like the banks as a reopening trade. I think the cheap stuff earns more than enough to pay for the hedge, and I think there's a chance that both legs of the trade perform, where value rallies as the growth bubble pops.

The best writing I have seen on the growth bubble popping is from GMO (linked above) and AQR, which put together a long piece demolishing the idea that value investing is not going to work anymore "because disruption":

Besides just an inherent discomfort with randomness, part of the issue is confusion about why value works at all. It does not depend on getting big events or trends right. It does not depend on having perfect accounting information. Certainly, it does not require a lack of massive technological change over time. No matter what the situation, it simply needs investors to net overreact. Companies that are cheap need to tend to be a bit too cheap for whatever set of facts exists at that time, and expensive companies need to tend to be a bit too expensive. For instance, it’s OK if there’s more monopoly power for a few firms today than before (or any other thing being different this time), as long as humans will still tend to overdo estimates of how powerful and long-lasting those monopolies will be, and vice versa for cheap stocks that lack these advantages.

Some charts that I am watching to measure the growth vs value inflection: Tesla vs Toyota, NASDAQ vs Small Banks, Peloton vs AerCap, Zoom vs Exxon, Carvana vs Penske, and Russell 1000 growth vs value.

Note that R1K value's (IWD) top sectoral holding is 20% financial while the R1K growth's (IWF) top sectoral holding is information technology (45%!). It's Apple vs Berkshire - which is obviously funny since Berkshire has an Apple position.


CP said...

From Lyall:

It is important to understand that market inefficiency is structural and behavioural, not informational. Many investors attempt to invest on the basis that market inefficiency is informational in nature, and dedicate tremendous amount of time and resource to trying to come up with better information than the next guy. However, in today's markets, the primary source of inefficiency is structural/agency driven, and the way to exploit that is not to acquire better information, but to have a structure that allows one to engage in long term value arbitrage that other investors cannot (often taking the form of buying underlying assets that are actually low risk, but are priced as if they were very high risk because they are part of an asset class that is generally perceived to be high risk). This requires a wide and unconstrained mandate (by geography, asset class, etc), long term capital, a rigorously long term approach, and an extreme tolerance for volatility and benchmark variation, which requires patience and emotional fortitude that is sorely lacking in today's instant gratification world.

Outperforming in the long term is actually not very difficult, but it requires highly lumpy results, often marked by long periods of lackluster returns, punctuated by short periods of spectacular results, which happen alongside liquidity flywheel/momentum reversals, which are inflection points that do not happen very often. Furthermore, usually, the worse value is performing, the closer one is to the end of a liquidity flywheel bubble cycle (value had a woeful time in 1999, for instance), because value is the 'anti-bubble' expression - a Newtonian equal and opposite reaction - of liquidity flywheels driving bubbles elsewhere in markets. It is redemption flywheels that drive value opportunities, and redemption flywheels are often the result of investors pulling money out of unpopular areas of the market in a rush to get exposure to hot areas of markets.

Taking advantage of long term opportunities is extremely difficult for investors with the wrong structure and wrong investors, however, as massive redemptions will likely happen right when opportunities are most ripe, and not all funds will be able to survive the inevitable lean periods. Value funds shut down en mass in 1999, for instance, and the same thing has been happening of late. Lean cost structures and - ideally - large principal FUM participation from the fund managers is a must.

Outperforming in the short term with consistency, by contrast, is extremely hard. The best way to do it is usually a momentum strategy, which works most of the time, but occasionally yields disastrous results on sudden momentum reversals. Momentum is the polar opposite of value - it generates good returns most of the time, and disastrous returns a minority of the time.

The latter strategy is a more remunerative strategy for fund managers, however, even if it often leaves long term investors worse off, which is why it is more popular/common. While the good times roll, large performance fees are banked, and it is investors that are left with the losses when it all turns to custard. This is why value investing remains relatively uncommon, despite its long track record of success, and in my view a combination of agency conflicts, information asymmetry, volatility-phobia, and the desire for quick results, will all but ensure market inefficiencies continue, and considerable opportunities for long term value investors will remain for many generations to come.

CP said...

When everyone has nominal revenue growth, business models based on profitless revenue growth won’t get the same valuation multiple.

CP said...