The current UK stock market represents a “Selfridges’ sale”, with investors flocking to expensive shares that have already seen their heyday, River and Mercantile Asset Management’s CIO of equities has said.
Hugh Sergeant, who runs River and Mercantile’s UK Recovery and Global Recovery funds, said investors have been powering the latest rally by bidding up the parts of the market already favoured, while ignoring shares on less lofty valuations.
“Even in this current market rally investors seem to be buying the already expensive stuff rather than the cheap stuff,” he said.
“It is akin to a Selfridges’ sale advertising 50% off everything apart from new season items – which will actually be 50% more expensive than normal – only for all the shoppers to then decide they actually want to buy the really expensive stuff, in the belief it must be expensive for a reason,” he said.
“Conversely, they do not buy the items discounted by 50% because they believe they must be cheap for a reason.”
This behaviour follows the end of a 12-month period of uncertainty in the global economy which culminated in last year’s equity market sell-off. So far in 2019 the end of global economic uncertainty, combined with improved trade talks and ‘lower for longer’ interest rates, has made a more convincing case that we are now seeing improvements in the outlook for economies across the world.
A corresponding move upwards has been seen in equity markets, but Sergeant said this shift in mood has yet to convince equity investors to look more broadly for opportunities.
“Despite this improving economic cycle, Mr. Market seems far more comfortable paying higher and higher prices for perceived safety (for example the safety of government bonds and their equity proxies) and ‘guaranteed’ growth, rather than diversifying his capital allocation to include the many and significant bargains that we have found both in the UK and globally,” he said.
“Indeed, it appears that some shares have temporarily become Giffen goods, which all students of Economics GCSE will know are those rare products that people seem to want to consume more of as they become more expensive. At the moment, ‘expensive’ appears to be good for shares (perceived as more reliable, less disrupted, faster growth) and ‘cheap’ appears to be bad (perceived as less reliable, more disrupted, more cyclical, slower growth).”
Sergeant, who uses an investment philosophy focused on Potential, Valuation and Timing (PVT) when constructing portfolios, said value stocks have therefore been left looking cheap in absolute terms, but particularly so when compared with the high valuations put on other factors such as quality, growth and momentum.
“The value factor has been undermined over the recent past by the rolling over of the global growth momentum that was seen in 2017 and early 2018,” he said.
In Q4 2018, economic momentum weakened, and the market started to discount the next recession, leading to dramatic falls across asset classes. This gave investors further encouragement to look for safety in the shape of historically reliable growth and quality stocks and avoid the higher perceived risk of value.
However, Sergeant said the flows seen into these growth stocks could be set for a slowdown in favour of the latter.
“The pessimism regarding economic growth appears to be peaking just as growth momentum bottoms out. Lead indicators are starting to rally, led by China, and followed by Europe, with the US actually a laggard as it plays catch-up on interest rate policy,” he said.
“A bottoming out of the shorter-term parts of the global growth cycle should therefore support value-type stocks and hopefully reduce the flow of ‘hot money’ into global growth stocks and bond proxies,” he said.