As central banks grapple with still-high levels of inflation and softening economic growth, changes in financial system liquidity have been met with market volatility.
Today’s macroeconomic backdrop—characterized by high benchmark yields, a shrinking Federal Reserve balance sheet and a declining money supply—appears to be closer in spirit to the mid-2000s than the bull-market years preceding the current Fed tightening cycle.
Recent strains in the banking sector underscored the pronounced vulnerabilities inherent in today’s financial system and the potential for unintended consequences as authorities attempt to unwind years of highly accommodative monetary policy.
- We believe investment success will be predicated less on exposures to particular styles or geographies and more on identifying quality companies globally whose tangible and intangible attributes position them to navigate a complicated environment.
The ample liquidity that predominated in the years following the global financial crisis fueled a prolonged period of growth stock outperformance at the expense of value names. However, changing macroeconomic dynamics in 2022 ushered in the more volatile investment environment that persists today.
These novel conditions contributed to a pronounced shift in favor of value stocks in 2022, but we’ve long been wary of extrapolating market trends. Indeed, growth stocks have outperformed their value counterparts handily year-to-date 2023, as easing financial conditions and moderating inflation pressures have helped markets look past a range of potentially destabilizing factors, including the recent strains in the banking sector.1 But just as we didn’t expect 2022’s results to represent the beginning of a durable value renaissance, we don’t expect early 2023’s results to mark a renewal of extended growth supremacy. In fact, given ongoing uncertainties and elevated market volatility, we believe the stark growth/value binary that has been so prominent in recent years is likely to be replaced by something more idiosyncratic.
In our view, the most important factor that may influence stock returns could be the ability of individual companies to execute in a challenging operating environment rife with tail risk. That is to say, after many years during which success was determined by the vicissitudes of investor preferences around sectors, styles and geographies, we believe the quality of a company—as reflected by a range of tangible and intangible measures—ultimately will determine its performance.
The go-anywhere, benchmark-agnostic approach of First Eagle’s Global Value team allows us to seek out what we believe to be quality businesses across global equity markets—even in parts not traditionally associated with the value investing that is our heritage. When purchased at what we believe to be a “margin of safety” to our estimate of intrinsic value2 and assembled in thoughtfully diversified portfolios, stocks that reflect our quality bias may help clients avoid the permanent impairment of capital with the goal of generating long-term real returns across market cycles.
That Was Then…
In response to the global financial crisis and the tepid economic growth that followed it, central banks globally spent many years maintaining policy rates at or near the lower bound while providing massive liquidity through large-scale quantitative easing programs. The repressed interest rates that resulted beget low discount rates, heightening the appeal of the future cash flows of long-duration growth stocks versus the here-and-now cash generation of value names. Discounted cash flow analysis sounds complicated, but we believe the math is fairly straightforward: When the risk-free rate is 0%, a $100 payout 10 years from now is worth $100 today; at 4.5%, this same $100 is worth only $55 today.
As shown in Exhibit 1, the equity bull market that began in early 2009 initially benefitted stocks equitably across styles before discount rate dynamics ultimately won out in mid-2014 to fuel the significant outperformance of growth stocks through the end of 2021. The technology sector was the focus of attention among market participants bidding up the prices of stocks with longer-term cash flows, providing an outsized benefit to the growth indexes in which most resided. As shown in Exhibit 1, the MSCI World Growth Index—which attributes more than 36% of its market cap to the tech sector—had a cumulative return of 164% over the seven-year-plus period compared to 34% for its value analog—which has a tech exposure of only 9%. Performance in the US was even more pronounced in favor of growth and tech.3
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