Is the WAAAX melting?

Alex Cowie

It's not just Afterpay that has slipped recently, a few of the WAAAX stocks seem to be melting. Yet this may just be part of a wider trend of capital switching from growth stocks to value stocks. By one measure, the two have diverged by 13% in the last two months. 

Growth has had a good run since 2016, but is it really now time to dust off our copies of the Intelligent Investor and buff up on Buffett quotes? One good starting point to answer that is to understand the drivers of the recent change of trend. 

We asked Vince Pezzullo from Perpetual Investments, James Miller from Firetrail Investments, and Alex Shevelev from Forager Funds to explain what has been behind this recent action. Read on for their views.  

Three drivers that stand out

Vince Pezzullo, Perpetual Investments

1) Bond yields

Bond yields backed up very sharply through September, coinciding almost perfectly with the rotation to value. The US 10 year went from 1.46% on 4 September and rose to 1.90% on the 13th of September. When bond market sentiment changes, it flows through to all asset classes.

Did the Fed loosen policy by 40 bps? Of course not. The rates market simply decided – independently of Fed guidance – that it wanted significantly more compensation to own them; and the spike in yields steamrolled momentum and growth stocks. A more sustained backup in bond yields will likely produce a more sustained rotation.

Also, investors need to keep their eye on the corporate bond market. Interest rates there have also run at very low levels for a long time. When the credit cycle rolls over and bond-holders of loss-making companies want their money back, this will be a difficult period for many pie-in-the-sky stocks that have driven the growth style in recent years.

2) WeWork is a red flag

There are many stock listings this year that defy gravity and reason; The RealReal, Uber, Beyond Meat. But WeWork has in many ways become the totem for excessive valuation. In the private market, the valuation had been as high as $47 billion. But public investors, despite absorbing so many richly priced companies this year, finally baulked.

On September 5th the first reports came out that WeWork’s IPO valuation might be halved. Four days later Softbank, the biggest shareholder, wanted the IPO put on hold. By 13 September there were rumours that $10 billion might be the IPO price, and just 3 days later the IPO was shelved. That’s an -80% decline in a few weeks

Despite its association with tech startups, there are many that see WeWork as just a leveraged real estate company. Either way, it's just another red flag for the excesses in the pre-IPO market.

3) Trade peace

There was a breakout of peace in the trade war. This might have been partly behind the rise in bond yields above, but it’s a reminder that geopolitical risks also hover in the background. Sometimes they produce negative shocks that could send interest rates and policy settings lower, but we also have to consider the opposite.

What if the US and China patch up their differences and sign a trade deal? Will the bond market sit idly by on that news or will yield rally? What if Brexit is resolved nest week? Other things being equal, a repricing of sovereign risk seems logical and would flow into other financial markets.

Investors start to question frothy valuations

Alex Shevelev, Forager Funds

Value can mean a lot of things. Some take it to mean low price-to-book, low price to earnings, and high dividend yields. Most, ourselves included, are just trying to buy a stream of future cash flows for less than what we think they are worth.

Growth is absolutely an important part of any business valuation. Who wouldn’t prefer a growing business over a shrinking one? We want to be sceptical about growth, reflected in the price we’re prepared to pay, rather than oblivious to it.

But faster-growing stocks have been trading at record premiums over slower-growing ones. And within that fast-growing basket, there’s a particularly frothy segment of speculative stocks. 

There are now more stocks on the ASX with less than $50m of revenue but market capitalisations of over $500m than there has been at any point in the last ten years.

The narrative for many speculative stocks, driven by news flow, momentum and the promise of huge revenue growth, is starting to be questioned. 

Globally, look at the failure of the WeWork IPO. Locally, see the recent broker shunning of darling Afterpay and the well-publicised short thesis on Wisetech.

So, what is likely to perform better over the next decade? It won’t be the speculative and popular. 

Instead, intelligent and sensible investment in stocks, be they classified as growth or value, will win out over the long run. 

Fiscal stimulus required to sustain the move

James Miller, Firetrail Investments

With the benefit of hindsight, there are several factors that contributed to the sudden reversal in the trend for value.

The most powerful of these was the calming of geopolitical risk. In particular, the de-escalation and potential calming of the trade war between the US and China, as well as a higher probability of a Brexit deal between the UK and Europe.

The above factors triggered a rise in bond yields. Growth and defensive assets subsequently underperformed. And value outperformed.

But the rally in value has been relatively subdued. To get a broad-based and sustained rally in value stocks, fiscal stimulus is required to ‘lift all boats’ across the economy, rather than just low interest rates driving asset prices higher.

We believe it is near impossible to time the turning point in growth and value cycles. Instead, investors could instead focus on the company-specific opportunities and aim to buy companies at a material discount to their intrinsic value. 

This allows investors to buy undervalued growth and value companies and largely ignore things they can’t control or predict.

In summary

Looking across the commentary from Vince, James and Alex, there were some common themes, starting with the fast-changing geopolitical picture. The far-reaching effects of the trade war have put the global economy under strain, and any continued improvement will likely see higher rates in anticipation of a better economic picture. 

This chart shows the US 10-year over the last 12 months with the uptick that started in early September coinciding with the trend change for growth and value. 

Source: CNBC

Democratic political adviser, James Carville, once summed it up perfectly when he said:

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

The bond market controls everything, not just growth/value rotations. So all eyes will be on what happens here next. 

The WeWork debacle is symptomatic of these factors and recent events could conceivably become a case study for the financial history books. In a recent fund manager discussion that we hosted, we looked at the WeWork story and its implications; you can see this here.  

Read more

While it's not in the DNA of value investors to get excited about a short-term move like this, we wanted to flag it and explore the theme further for you. In my previous wire, Vince, James and Alex shared their observations around this trend. In our next wire, they discuss stocks that are positioned to benefit. 

Please click 'FOLLOW' to get it first. 

3 stocks mentioned

4 contributors mentioned

Alex Cowie
Alex Cowie
Content Director

Alex happily served as Livewire's Content Director for the last four years, using a decade of industry experience to deliver the most valuable, and readable, market insights to all Australian investors.

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