As always during signs of a rotational shift in market performance, there’s been plenty of talk on equity leadership and its sustainability. We’ve seen signs of a V-shaped equity market recovery from the mid-March lows, though in the past week some have already moved on to referencing a ‘kangaroo’ market. Either way, investor momentum had become increasingly stretched.
In a raucous style that would not be out of place in the House of Commons, an exchange of views between value and growth investors quickly ensued. The former tend to rub their hands gleefully and herald the coming of a new dawn, while the latter will scoff and take great delight in reminding the others of their 14-year style outperformance. The tit-for-tat then moves on to more serious considerations around the likely duration of the rally and the potential drivers of its sustainability.
Regardless, the cumulative relative performance of cyclicals is still near all-time lows, unsurprising given their high sensitivity to changes in PMIs and economic data. However, the re-opening of the economy and significant developments, like the proposal for an EU Recovery Fund, do begin to offer a more compelling narrative.
But this type of debate often leads to the same misconceptions. The notion that all ‘growth’ stocks will underperform in this environment is not true, particularly if they are economically sensitive businesses or have exposure to a cyclical end-market. Equally, the idea that ‘value’ investing is simply a dash for trash – full of the sort of rubbish that Tom Hanks hilariously spent time on during the 80s slapstick flick ‘The Money Pit’ – is equally false. There are plenty of cyclical stocks that in our view are undervalued, have resilient business models, strong management teams and long-term growth potential. Whether the market recognises that is part and parcel of investing.
Get your moat
From a bottom-up perspective, one of the most important characteristics for long-term investors in determining business quality is market leadership – a durable competitive advantage, more popularly referred to as the ‘economic moat’.
A recent call with the management of low-cost airline Wizz Air* helps illustrate this point. We know that travel and leisure – aviation in particular – is a highly cyclical industry, which has clearly been impacted by COVID-19 and the global lockdown.
Industry expectations of a return to 2019 travel levels are rather bleak. Yet, while many of its competitors are in financial trouble, Wizz Air is expected to thrive. The business is a leader in the low-cost short-haul market, with ambitious growth plans to expand fleet capacity and drive market-share gains as it broadens its base and route network. Its management has been quick to point out that this is arguably the first time in 10 years that leverage is with the airlines, not airports. Few, though, are in a position to capitalise. We believe Wizz’s healthy cash-positive balance sheet and desire to grow sustainably make it better placed than most.
Another cyclical business is RHI Magnesita*, the global leader in refractories. Softening production and falling levels of demand were among its industry’s woes during the first half of this year. However, it’s RHI Magnesita’s product innovation and solutions leadership that we believe represents a strategic strength and should enable the company to enter new markets as more of the global economy recovers.
In other ‘growth’ parts of the economy that are still exposed to a cyclical consumer environment, we believe market-share gains are also supportive for leaders Boohoo* and Just Eat Takeaway*. They continue to see new customer acquisition as they benefit from enduring structural advantages that include the online channel shift, where they both have a position of strength and a strong brand proposition.
Cyclicals or defensives? Quality or growth? We can discuss the merits of styles and factors, but ultimately it is market leadership and returns that matter most. Market moves may indicate a lack of decisiveness and sentiment may swing between bull and bear investors, but those with a more positive outlook and mindset should be able to find opportunities to position themselves for the long term. ‘Commitment challenging, but opportunities for the nimble?’ I’ll go with the latter part of that sentiment and back the long-term winners.
*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.