(Runtime: 4 min, 54 sec; size: 55.16 MB)
Craig Jerusalim, senior portfolio manager, Canadian equities at CIBC Asset Management.
What happened to growth over the past six months? Growth investors had a tremendous run leading up to the COVID-19 pandemic and not surprisingly, [ saw that dominance] accelerate post-COVID as the world quickly shifted online. That later strength was fueled by the combination of bored individuals, many being paid not to work and looking for ways to spend their money and pass the time, as well as software and technology businesses being unfazed by global lockdowns. This led to the explosion of retail investors using easy access trading apps like Robinhood, adding fuel to the momentum fire, exacerbated by Reddit boards and the powerful FOMO effect or fear of missing out.
In this case, it was hard for many people to watch lesser skilled individuals get rich by buying highly speculative meme stock and crypto assets in seemingly easy, get rich quick gap ups in price. Extremely low interest rates increased the incentive to borrow in order to lever up those returns and reduce the opportunity cost of holding safer assets like bonds. Those generationally low interest rates also increased the value of long dated future cash flows that are discounted back to today, which allowed for money losing stocks today to appear attractive if a narrative could be constructed for those companies to eventually begin to earn profit, no matter how far into the future you had to project.
There are two important dates that I see as flipping the script on the growth versus value trade. The first key date was October 2020 when COVID vaccines were first deemed effective and ultimately approved in North America. The second key date occurred around November of 2021 when investors started to forecast and incorporate central bank hiking cycles into expectations. The four years leading up to the first key date, both in Canada as measured by iShares Canada growth ETF, had outperformed the iShares Canada Value ETF by over 35%. Since that first date, value has outperformed growth on a total return basis by over 50%, with much of the outperformance occurring in the past few months. This value over growth catch up has effectively canceled out growth dominance going back all the way to the financial crisis.
So why has value done so well, and more importantly, why has growth done so poorly over the past year? Many value stocks are tied to the general economy. Once the developed worlds refocus on the economic reopening, and away from the stay, play from home stock, a natural reversion to the mean occurred. Furthermore, energy and financials have the biggest influence on the value index, and rising rates plus improving supply fundamentals for energy give a rational boost to those cyclical value sectors. Meanwhile, the entire growth universe was definitely not one big technology bubble 2.0. The difference from 1999 is that many of the best companies in the world like Microsoft and Apple in the U.S. and Shopify in Canada did experience some multiple expansions, but simultaneously too many low quality fantasy securities that had no business trading at 20 to 30 time sales exploded in popularity and hype. So the errors coming out of that portion of the growth trade was not unexpected at all and is actually quite healthy when you think about it. And as I alluded to earlier, rising rates naturally have a downward influence on expensive multiples as the value of those long dated future cash flows discounted back to today are worth less.
So finally, where does this leave growth stocks at this point? The key now is to sort through the technology and growth company carnage and seek out the highest quality companies that have been tossed out with the proverbial bathwater to find the companies that can rise from the ashes and become the next 10 baggers. The abundance of momentum and technical hedge funds has definitely exacerbated the downfall of some of these great companies that are now trading in valuations comparable to many more traditional value stock, but still have more attractive growth attributes.
These companies look very good on a peg ratio basis or price to earnings divided by growth. The situation gives growth investors two chances to win. One, if those premium multiples ever do return. But secondly and more predictably, if there truly is confidence in the quality of the business model and the subsequent growth and earnings that we’re forecasting. And remember that a great company like Amazon has had to endure four different 50% draw downs, plus one 90% draw down on its journey to a trillion dollar company. So while growth investing isn’t for the faint of heart, it can be incredibly rewarding when done with discipline and conviction.