[vc_row css=”.vc_custom_1655390340944{padding-top: 20px !important;padding-right: 60px !important;padding-left: 60px !important;}”][vc_column][vc_column_text]As good vaccine news comes out, there have been some significant changes in stock market trends. Stay-at-home stocks, the momentum darlings of 2020 have lost their wings, while the extremely beaten-down value stocks have appreciated sharply. Is now finally the time, after years of momentum stocks leading the market higher, to increase allocations to value stocks? We believe the short answer is yes, but there are several pitfalls investors need keep in mind.
Flows into passive strategies like buying the S&P 500 continue to dominate and gain market share. Although the word “passive” is in the strategy’s name, the way these investments work are quite active and momentum-focused. As tech stocks outperformed, their percentage weightings in the indices increased. Each day, a higher percentage of each newly-invested dollars went to Tech, while underperforming industries like Energy received less and less. Tech has enjoyed a positive feedback loop, launching these issues higher and higher, while a negative feedback loop compressed Energy’s weighting to some of its lowest readings ever. With vaccines potentially boosting the economy in 2021, beware the passive investors, because their continued strangle-hold on flows will keep momentum stocks rising after the initial crowd has rushed into value.
Even if you believe, like us, that passive flows will continue for some time, it is still an excellent time to be buying a select-few value stocks. We are finding some companies that are not only cheap relative to the S&P 500 and Russell 2000, but they are also attractive on a stand-alone basis. Even if other investors ignore these companies, we believe an entity like a private equity fund or a larger company will see the potential to generate superior returns by acquiring these value companies for the cash flows. We are carefully increasing allocations to these ideas, with the knowledge that vaccine benefits will take most of 2021 until they materialize. By focusing on the next 3-5 years, we avoid the impossible task of timing a trough in value, while investing our clients in streams of cash flows at rock-bottom valuations.
Valuations on select stocks may be cheap, but investors should be wary of the type of valuation metrics used. Popular metrics like Price/Earnings and Price/Cash Flow ignore how much debt companies have. We believe this is a mistake in this age of near-zero interest rates. In fact, corporations have taken on record amounts of debt, and value spaces like Energy remain cheap because issues are declaring Chapter 11 bankruptcy, wiping out equity holders in the process. Instead, a thorough examination of balance sheets is required, and though this eliminates most opportunities, the ones that remain will be the survivors. A net-cash balance in 2020 is a rarity, but these companies can act from a position of strength – investing in growth through increased capital expenditures, or by purchasing assets of bankrupt companies through auction.[/vc_column_text][/vc_column][/vc_row]