Extreme stock market valuation spreads divide seasoned investors

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Two leading investors have come up with different strategies for dealing with the dizzying valuation gap between growth stocks and struggling sectors: trusting good deals or pushing aside traditional valuations.

So-called value stocks in sectors such as finance and energy – hit hard by the coronavirus crisis – have accelerated their recovery over the past week, supported by the Democratic Party’s second-round Senate gains this week latest which indicate increased government support for the US economy. Meanwhile, growth stocks, especially in US tech, continue to break records with only minor setbacks.

But in a note to clients on Monday, veteran troubled debt specialist Howard Marks warned that while it was “easy to be seduced” by low valuations, “invest on the basis of rote formulas and readily available fundamental and quantitative measures should not be particularly cost effective. “.

The comments from the founder of Oaktree Capital come days after Jeremy Grantham, co-founder of GMO, warned of a “bubble that’s starting to look like a real humdinger” in stocks. For him, one solution is to avoid as much as “your career and your business risks allow” and focus on emerging markets and value stocks.

The contrasting views reflect the difficulty for fund managers to reduce reliance on a small group of tech stocks and hedge against the risk of a market downturn while resisting cheap stocks whose valuations are not keeping pace.

In his note, Mr Marks said that the apparent distinction between values ​​of growth and value is neither “essential, natural or useful, especially in the complex world we find ourselves in today”. Often times, he says, “if something has a low valuation, there’s probably a good reason.”

Unlike previous decades, granular data on companies and markets are now easy to find, making it harder to select overlooked bargains, he said. As such, it “doesn’t make sense” for value investors to avoid high-value stocks or big-tech popular names, he added.

Mr Grantham, meanwhile, wrote last week that he was “waiting for the last dance” in exuberant markets. “Make no mistake… This could very well be the most important event of your investing life,” he said, citing examples of “crazy” investor behavior.

“Value stocks have had their worst relative decade ending in 2019, followed by the worst year in their history in 2020, with gaps between growth and performance value averaging between 20 and 30 percentage points, ”he said. Emerging market equities also suffered their worst performance against the United States in about half a century.

“We believe that it is in the overlap of these two ideas, value and emergence, that your relative bets should go,” he concluded.

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