The Weekly - Growth vs the value of a vegan sausage roll

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18/06/2019
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Growth versus value – two competing approaches to stock selection. But which is better? The answer is easy. We are, and have been, in a prolonged period where growth investing has been the more rewarding strategy. Value investing has certainly been a very painful experience over the last few years. However, we know investing is a cyclical business, so when is value going to replace growth as the more favourable strategy?

This is indeed complicated to answer because there are so many variables including Brexit, trade wars, and a very worrying escalation in the Persian Gulf between Iran and the United States. However, we believe that the deteriorating economic outlook could mark the start of a return to value investing.

Bond yields have fallen with the one exception of Italian bonds. The change in interest rate policy by the US has caused yields to come in across all fixed interest classes. Greece is trading at 2.8% down from 3.6% and is now only marginally ahead of Italy, mounting debt, and fractured politics are causing concern. Falling yields suggest the global economic outlook is deteriorating, and with talk of the US Federal Reserve cutting rates, and mutterings about a potential need for more Quantitative Easing (QE), it all points toward a difficult economic period approaching. QE normally indicates a positive for growth investing however, given that the measures have been in place for a prolonged period, we view this as simply tampering with the status quo.

If this is the case, then there is certainly an argument for value investing - a strategy where stocks appear to trade for less than their intrinsic value. Fundamentally, the investor must believe that markets are inefficient, and that not all information is priced into the cost of a stock.

A good example of this is Greggs the baker. At the start of the year Greggs was trading at £12.66 per share, but now the current market price is £22.60. This represents an increase of 77% in its share price. If you multiply the difference between the two share prices (£9.94) by the number of shares Greggs has in issue, then they have added £1,005,530,400 – over a billion pounds of value. If you read any equity analysts note, then you would assume this was all down to the vegan sausage roll that Greggs introduced in January (Veganuary), hence why we have looked at the difference in share price between the start of the year and now. However, given that Greggs sell their sausage rolls for £1 each, we can’t imagine that they have sold over a billion vegan sausage rolls! Assuming a UK population of 66 million then it would mean each of us scoffing just over 15 vegan sausage rolls each. This doesn’t even assume the costs of producing and selling the vegan sausage roll.

Of course, the above is a rather crude way of looking at it and there are other variables. But we believe it does illustrate that markets are not always as efficient as people think and that value is still out there. Indeed, Greggs could very well still be undervalued, even given the remarkable increase in its share price. There is certainly a danger that too many fund managers are on a one-way momentum growth train. Investments in growth stocks such as tech are all the rage. But were we to enter a period of economic decline, then a return to fundamentals would happen, which would inevitably lead to a correction in growth stocks. Recent falls in companies such as Facebook indicate that we may have already reached that point.

Value stocks are often better protected in the event of turbulent markets, as they don’t sit on lofty valuations so there is limited downside. What we might find is that after ten years of growth being the more rewarding strategy, which is understandable given the high levels of QE, investor disappointment when expectations don’t meet valuations is severely punished. However, while we believe a shift is underway, it might be some time before it materialises. We believe that certainty over Brexit will help the move to value investing – the stocks that have been out of favour. The hope is that we will get some clarity on Brexit when the next Tory leader is announced. (Sources: FE Analytics & Greggs)

The week that was 

Global equity markets continued their recovery last week with most of the major indices concluding the week in positive territory. Markets were helped by the news that the proposed US tariffs on all Mexican imports had been put on the backburner. This followed an announcement from the Mexican President that reinforcements would be sent to the southern border to restrict the number of Central and South Americans illegally travelling north in the hope of reaching the US.

Having rallied strongly in the previous week, the S&P500 added a further +0.5% with the IT sector posting strong gains during the early part of the week. Closer to home, the FTSE100 rose by a modest +0.2% although the midcap focused FTSE250 lost ground due to weakness in the Pound. On the continent, the German Dax 30 and French CAC40 rose by +0.4% and +0.1% respectively whilst in Japan, the Nikkei 225 added +1.1%. It was a largely uneventful week in the bond markets with 10-year gilt yields rising by 3 basis points (bps) to 0.85% with the US equivalent treasury yield largely flat at 2.09%. With regards to currencies, Sterling remained weak as political uncertainty and disappointing economic data led the currency lower. It declined by -1.2% against the Dollar to just $1.261 whilst its value versus the Euro dropped to €1.123 after a -0.2% weekly fall.

Finally, in the commodity markets, oil prices continued to lose ground with Brent Crude dropping by -2.0% to $62.01 a barrel. Concerns regarding global growth, in particular that delivered by China has resulted in Brent shedding -20.0% over the last two months, despite further oil tanker attacks in the vital Straight of Hurmuz. Meanwhile, Gold continued its recent rally with the precious metal adding a further +0.3% to close out last week at $1,350 an ounce. (Source FE Analytics)

The week ahead

Central bank meetings both at home and in the US are likely to gather plenty of attention this week. Whilst no interest rate changes are expected at either, post meeting speeches by both the Chancellor of the Bank of England Mark Carney and Fed Chairman Jerome Powell will be closely scrutinised for any indications regarding future policy.

In terms of economic data, the highest profile figures out of the UK this week are CPI inflation on Wednesday and retail sales numbers on Thursday. Headline US numbers are limited this week although there are several important housing sector figures due including monthly building permits, housing starts and existing home sales. In the Eurozone, flash monthly PMI data is due at the end of the week with modest improvements in both the manufacturing and services sector expected. However, it’s worth remembering that the figures are subject to change given that they are based on just three weeks’ worth of data. Elsewhere, the Bank of Japan hosts its own policy meeting on Thursday although data from both it and China is in short supply on this occasion. (Source FE Analytics)

 

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Data sources - Datastream and Forex Factory - Accessed 17.06.2019

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