One of their current rebuttals to value investors from those investors not in the value church (and boy, there do seem to be a lot of them these days) is that our stocks are cheap for a reason. With the clearest value opportunities currently found in energy, banks and consumer-related stocks, it is true that there are some structural issues that value investors need to wrestle with. Although we would argue that some of these concerns are way over-cooked, some terribly clever chaps at Sanford Bernstein highlight that the dislike of value is now so great that it is apparent within many sectors.
The chart below illustrates this nicely and compares the cheapest stocks on price-to-book with the most expensive stocks across sectors. Their number crunching suggests that the cheap stocks look as cheap relative to the expensive stocks as they have done for 25 years and that value opportunities are becoming far more diverse.
Figure 1: Relationship of cheap stocks versus expensive stocks (on price to book) on an industry neutral basis
Source: Sanford Bernstein
We appear to have arrived at crunch time. The language of central bankers clearly modified at the end of June. They have clearly decided that enough is enough and that the time has come to start raising interest rates and discussing reversal of quantitative easing (whilst not shocking the market too much). They have a tariff of justifications for this ranging from the strength of the global economic upswing and the risks to inflation of the low levels of unemployment to a desire to reverse QE before the unknown risks of the initial strategy become apparent and to have interest rates at a decent level ahead of the next recession.
The market shrugged off this ‘forward guidance’ (remember that?) – either believing that the central bankers were all mouth and no trousers or that at the first signs of market weakness they would lose their nerve.
The market reaction could be too sanguine. Recent political results, the mood of the electorate and the language of central bankers suggests that whether the politicians like it or not we are transitioning from monetary policy to fiscal policy. Having previously had one huge buyer of government bonds (the central bank) the market could be looking at two big sellers (the government, to fund increased spending and the central bank reversing QE). With real yields standing at historically low levels this is a significant risk for bond prices and those assets most correlated to them.
What if the central banks fail to carry through this normalisation strategy? In this scenario the market could conclude that the new normal is low interest rates and QE forever; not necessarily an issue until the next recession, market crisis or if the unknown risks of QE become apparent. But a very unhealthy position to be in.
Our conclusion is that we are entering a new era. What has worked so well in a period of declining bond yields is likely to work badly as bond yields increase. Low risk becomes high risk and high risk morphs to low risk. There may be a few false starts to this process, but we prefer to be positioned early for this rather than battle with the masses to restructure a portfolio once momentum meaningfully changes direction.