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‘Value drought’ claims latest victim as growth stocks power on

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In the 1985 film Brewster’s Millions, Richard Pryor plays a minor-league baseball pitcher who struggles to waste $30m in 30 days. If the cult comedy were set today, a certain investment strategy might provide a quick way to torch the money.

“I finally figured out what Richard Pryor should’ve done,” Clifford Asness, the head of AQR Capital Management, recently tweeted. “Levered value stocks.”

Such grousing is increasingly common among investors whose style is to buy value stocks — unloved and cheap companies in often unfashionable industries — after a dismal decade of underperformance. But in 2020, value investing has gone from poor to pathetic. This week, it claimed a big victim. 

AJO Partners, a $10bn value-focused hedge fund, on Wednesday announced it would shut down and return its money to clients, blaming the decision on the length and depth of the value downturn.

“The drought in value — the longest on record — is at the heart of our challenge,” Ted Aronson, AJO’s founder, wrote in his final letter to investors. “We still believe there is a future for value investing; sadly, the future is unlikely to arrive fast enough — for us.”

For value investors, a bout of underperformance is nothing new. Many ruefully recall how dismally they did during the dotcom bubble, only to roar back when it burst. The Nobel laureate economist Eugene Fama has shown how value stocks have over time rewarded investors since at least the 1920s. 

Line chart of Rebased performance as of April 3, 1995 showing Growth stocks are hammering value stocks

However, the end of a pedigreed investment group — AJO was founded in 1984 and managed over $30bn at its peak in 2007 — underscores just how brutal the market environment has been lately. 

“We have read plenty of value factor obituaries over the decades, but let’s be clear: value performance is bad, the worst it has been in 100 years,” Andrew Lapthorne, head of quantitative research at Société Générale, wrote in a note this week. “It is important to try to understand what’s gone wrong.”

Unfortunately, the conclusions of analysts are largely as muddled as the performance of value itself.

SocGen reckons the root cause is that cheap stocks are now staying cheap — or becoming even cheaper — because they tend to be found in more economically sensitive sectors, and broadly speaking global growth has been anaemic since the financial crisis of 2008. Meanwhile, sagging bond yields are pushing investors into expensive, faster-growing stocks in sectors like technology.

The Russell 1000 growth index is up almost 30 per cent this year, while the Russell 1000 value index is still nursing a 10 per cent loss in 2020. Over the past decade, US growth stocks have now climbed more than 300 per cent — three times the returns of value stocks. 

Bar chart of Net year-to-date returns by style (%) showing US value funds have struggled badly in 2020

Others blame outdated ways of measuring what is cheap. Historically, the main way of doing this has been to compare stock prices to a company’s book value, a measure of its assets minus its liabilities. However, this metric does not include intangible assets — such as brands and intellectual property — which these days often make up more of a company’s worth than hard assets like factories.

Just as home buyers factor in the quality of local schools, investors should take more ephemeral but important aspects into account, argues a paper from Research Affiliates. It calculates that by incorporating intangible assets, much of the decade-long value underperformance disappears. However, Savina Rizova, head of research at Dimensional Fund Advisors, has found the opposite: intangible assets are hard to value accurately, and the noise they introduce is actually unhelpful.

Meanwhile, AQR has kicked the tyres on a wide variety of explanations — such as a secular tech stock bull market, intangible assets or the emergence of a handful of dominant “megacaps” — and found that even after accounting for those, the underperformance of value is still historically extreme. The central reason is simply investors paying more for stocks they love and shunning to an unprecedented degree those that they hate. As a result, the “mispricings are real, clear and gigantic”, Mr Asness notes.

The question is whether value can stage a comeback. Peter Oppenheimer, Goldman Sachs’ chief global equity strategist, thinks at least a temporary reprieve is likely soon, especially if a virus vaccine emerges and kicks bond yields higher.

Abhay Deshpande of Centerstone Investors is optimistic that a durable renaissance is inevitable at some point. History shows that the more pain value investors suffer, the stronger the comeback is. “The good news is that the dream is only deferred,” he said. “Crowds go crazy as a group and individually regain their sanity.”

Some might even take the AJO closure as a sign that a revival for the strategy is nigh, as was the case in 1999-2000, when many big value managers also capitulated.

“Ghoulishly, everyone throwing in the towel is often a good sign, especially when solid people like Ted are doing it, it’s an indication of stress. But I don’t want to oversell it as a timing indicator,” said Mr Asness. “I’m not sitting here raising my value tilt, just because one of my heroes threw in the towel. I’m just sad about it.”





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European stocks stabilise ahead of US inflation data

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European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.



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Potash/grains: prices out of sync with fundamentals

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The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

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Amazon sets records in $18.5bn bond issue

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Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.



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