To do well over the long term, you need to be positioned differently – particularly when markets are going through change. Fiona Jeffery, from our offshore partner, Orbis, discusses Orbis’ positioning compared to the market, looking at what Orbis is excited about and what may make them look smart or foolish depending on how things play out.
Markets experienced stellar returns in the decade following the global financial crisis (GFC, March 2009-December 2010), with the MSCI All Country World Index returning 14% per annum. The post-GFC environment provided almost perfect conditions for a new economy, so-called “growth stocks”, in particular US technology, to outperform:
- Relative valuations for these companies at the start of the period were very attractive, especially given their growth potential
- The market environment was very stable with low energy and commodity prices and limited currency volatility
- Inflation rates were low and long-term interest rates fell to historic lows
- We also saw massive central bank stimulus post the GFC, which accelerated during COVID-19
There is no denying that many of these growth companies – names like Microsoft and Apple – are high-quality businesses with strong fundamentals. But there was also a lot of hype around much more speculative businesses, some of which had little-to-no underlying profits. Amid this hype, value shares – mostly old economy businesses such as banks, industrials and energy – underperformed.
Periods where markets are up a lot are tough for contrarian stock pickers, and this environment provided a headwind to our performance. The Orbis Global Equity Fund (Global Equity) underperformed by 1.6% per year after fees from 2009 to 2021, and the Orbis Global Balanced Fund (Global Balanced) by 1.2% after fees from inception in 2013 to 2021. Of course, it’s important not to use the market environment as an excuse – ultimately, our stock selections and asset allocations detracted value over this period.
A change in course
But then 2022 happened.
Russia invaded Ukraine, inflation rose rapidly in many parts of the world and central banks raised interest rates in an attempt to combat it. Stocks and bonds ended the year down almost 20% each, which left most investors with nowhere to hide. And perhaps most critically, the massive central bank stimulus came to an abrupt halt. This meant the forces driving markets looked very different.
Returns in almost every part of the market were negative. Energy was one of the few sectors that delivered positive returns, perhaps not surprising given the war in Ukraine. Even value was negative – but less negative than the rest, as this environment was a tailwind for value stocks. In 2022, it was the growth names that drove the market down.
And while there was a lot of bad news out there, for stockpickers like Orbis, who are different from the crowd, there was a lot to be excited about. That’s because this is exactly the kind of environment we thrive in, and our stock selections and asset allocations benefited from market tailwinds.
Global Equity outperformed by 7.5% after fees and Global Balanced by 22.6% after fees. In a year where stocks and bonds were each down by almost 20%, Global Balanced’s absolute return of 1% stood out.
Following the events of 2022, we felt we were at an important juncture for the market environment. As one of our colleagues put it: “The past 10 years were great for markets but tough for stockpickers; the next 10 may be tough for markets but great for stockpickers.”
And another twist and turn…
But the tide turned very quickly in 2023, returning to post-GFC conditions. The market has once again been dominated by US technology stocks and value has lagged, raising two important questions:
- What has been different in 2023?
The market has become extremely excited about the impact artificial intelligence (AI) could have on earnings’ potential, driving the performance of the “Magnificent Seven” as they have been dubbed (Apple, Microsoft, Amazon, Alphabet (Google), NVIDIA, Tesla and Meta (Facebook)). The S&P 500 has returned 19% from January to July this year. But this doesn’t tell nearly the whole story: The Magnificent Seven are up 66% over the same period. And the rest of the index – just 9%. This rapid change in the environment has provided a headwind for us again. It’s tough to outperform when the market is this narrow: Global Equity has underperformed by 3.4% after fees in 2023 (to end July), and Global Balanced by 1% after fees.
We think it is far too early to tell who the winners in AI will be – but the market seems to be betting pretty heavily on NVIDIA and Microsoft and most of the Magnificent Seven. While we don’t own the likes of NVIDIA, we can still participate in exciting growth opportunities in the sector without having to overpay for the privilege. The approach we’re taking is more like the investors who bought shares in the companies who made picks and shovels during the Gold Rush, rather than prospecting for gold. Some might see this as a boring approach, but we think it could be rewarding in the long term.
- Do we still think the environment has changed?
In short, yes. While the market may think we are back to the post-GFC era, and while 2023 results year to date look a lot more like the post-GFC era than 2022, we still think the market backdrop has changed:
- Starting valuations for growth companies are much higher than a decade ago
- Oil, energy and commodity prices are off their peaks, but still high
- Geopolitical tensions and volatility are still well above the post-GFC era
- Inflation might be easing a bit, but it is still high
- Rate increases might be slowing, but we are a long way off the extremely low rates of the last decade
- We haven’t seen any of the stimulus that dominated the post-GFC era
It is also important to note that bubbles don’t always deflate in a linear way, and recoveries don’t always last. We are still optimistic about a changing market environment, which we interpret as exciting, rather than worrying. It all hinges on how you navigate the change.
You don’t win in the stock market by doing the same thing as everyone else. To outperform, you have to be willing to do things differently. Often, what you don’t hold can have as much impact as what you do hold, and if history is anything to go by, avoiding last cycle’s winners is a good place to start.
Being different has been very beneficial for our clients in the past. Global Equity’s outperformance since inception has not come in a straight line and most of the value we have added has been during periods of market change. We believe that active managers, who follow a disciplined approach and are willing to look for opportunities outside of the popular areas of the markets, have the potential to protect capital better than a passive manager during periods of market change.
We think there are lots of opportunities to be positioned differently by buying undervalued stocks today. Over history, there have been times when it has been worth it to pay a little bit extra for growth companies – but we don’t think this is one of those times. This is because the valuation gap between value and growth is wider than normal today, and in the past, this has often been a good time to buy value shares.
So, it shouldn’t come as a surprise that we are currently finding many opportunities in those value, old economy shares. But an important caveat is that this doesn’t mean we always will. We are not classic value managers; we are prepared to go to the areas of greatest opportunity.
When we look at the portfolios, our Global Equity and Global Balanced funds are positioned very differently. Many of the names in the Global Equity Fund’s top 10 are not widely held. And our Global Balanced Fund’s asset allocation looks very different from the traditional mix of 60% equities and 40% bonds.
Of course, we can’t know if our stock selections and asset allocations will add value relative to the market over time, but we do know that our portfolios are very different, and having that diversification is helpful. We are excited by our positioning.
Smart versus foolish?
Given our approach and our current positioning, there are some instances where we may look smart, and others where we may look foolish:
We will appear smart:
- If interest rates stay high and we don’t see more central bank stimulus, that should be a tailwind for value shares
- If technology stocks underperform and the market becomes less narrow
- If the rest of the world outperforms the US
Conversely, we will appear foolish:
- If interest rates fall and central bank stimulus resumes, as this should be a tailwind for growth shares
- If the AI rally continues, and the market continues to be driven by just a handful of stocks
- If the US drives market performance
We can’t guarantee what the market environment will bring. However, we can assure you that we are excited about the current environment – and the opportunity to add value for our clients in the future.