Why Lazard believes the Value trade is far from over

Goldman Sachs' global commodities czar Jeff Currie described 2022 as the year when structural underinvestment in his asset class suffered a "revenge of the old economy". Well, if Value is the "old" (read: pre-2011) strategy for investing in financial markets, then 2022 has certainly been a year for this factor's comeback. 

The playbook of the last decade has been thrown out the window, along with all the free money and low interest rates from central banks. Now, the question has shifted to whether global inflation and interest rates will remain higher for longer. 

But in a year when Value stocks have outpaced their Growth counterparts, many investors are asking whether they have missed the boat. 

In this wire, Lazard Asset Management chief market strategist Ronald Temple will share why he believes inflation will remain structurally higher and recession risk remains very real. His colleagues Dr Philipp Hofflin and Warryn Robertson will then share their perspectives and why it could be a multi-year story for Value investing. 

Top asset allocation calls

• Equities are still not priced for a recession.
• Quality, valuation, and pickiness will win the battle. 
• Bond investors are too dovish - the peak for yields may not even be in yet. 
• Residential real estate is looking shaky, commercial less so. 
• Private equity investing opportunities will be more challenging but not impossible.

A recession is easy - but it's a regime change that's the challenge

Like many others in his field, Temple believes a global recession is coming. But unlike others, Temple argues this recession will be sharp and dependent on the intersection of a tight labour market and moderating inflation. 

But there is good news.

"I don't see any reason to be worried about systemic crises or the seeds of a Global Financial Crisis," Temple says. 

But that doesn't mean old assumptions about inflation are not being rewritten - far from it.

"Longer term, I do think we're in the midst of a paradigm shift for inflation where core inflation over the next three to five years is likely to be sustained around 3-3.5%," Temple says. 

"It's not alarming but compared to the last ten years, it's a material change."

But will Australia escape unharmed (again)?

There is no doubt we have had a remarkable run from an economic perspective. Before 2020, Australia was on a 27-year winning streak. And if you believe the optimists (for example, but not limited to, Shane Oliver), we'll avoid it again even if the US goes into one.

So are we really different from the rest of the world?

"The jury's out," Hofflin says. 

"When we look at other nations, wages are growing at a rate not compatible with inflation targets... but that's not happened in Australia and that's a significant difference."

The playbook for equities and bonds is (almost) the same

When BlackRock released its 2023 investment outlook earlier this year, the first thing everyone pointed to was its dramatic title:

"A new investment playbook"

The short summary of this outlook paper is that all the old norms and rules around markets need to be thrown out. They argue we are headed for a "new regime" of greater volatility, adding a "recession is foretold". 

So is Lazard just as pessimistic? Robertson says it still doesn't hurt to use your existing playbook. In his case, it's building a worst-case scenario until we know otherwise. 

"I build a bearish scenario, and then if I still find valuations that stack up in that bearish scenario, then that's when we buy the stock. That's consistent with the playbook we've used for 20 years," Robertson says. 

But - and here's that phrase we all love saying - there is something different this time.

"The 2010s is an aberration and in our opinion, we're not going back to multiples of 100-times on certain growth stocks. That was not a normal scenario," Robertson argues. 

"A lot of the structural factors like the dividends of globalisation which gave earnings growth during the 2010s is not there anymore."

Have you missed the boat?

If you weren't in value-oriented investments this year, you may be wondering whether it's now too late to get in. I'll let Hofflin answer the question for you. 

"The news is good here. That 2021 bubble in Australia was bigger than the dot-com bubble. The mean reversion still has a fair way to go," Hofflin says. 

"Just think back how far News Corp (ASX: NWS) and Telstra (ASX: TLS) - the stars of the dot-com boom - how long did it take for them to start trading on reasonable valuations again? It took three to five years. I think the same will happen here again.

"If people are underweight value, they need to remedy that as soon as possible. The time to act on that is now because, in another two to three years, that opportunity will disappear."

In his global domain, Robertson recalls that the big run for growth assets really started in 2008. But in 2022/23, value is the old strategy that will pay again.

"People have lost sight of what a normal market is," he says. 

"This will take some time to deflate. As an asset allocator, I think you shouldn't look at the last 10 years. Look at the last 20-30 years for an indication of the future." 

So what do we do?

Concentration and conservatism are the two mantras that could best sum up their house view right now. Robertson himself believes up to 3/4 of all stocks in their investment universe are still too expensive. 

"We're running a very concentrated strategy - and the portfolio is quite punchy," he admits. 

So which stocks are the ones worth owning? Lazard believes you should look for companies and assets with in-built inflation protection.

"Three-quarters of the global infrastructure doesn't have in-built inflation protection attributes so you need to sort those that do," Robertson says. 

"For those that do, there's some that have guaranteed inflation pass-through and those that have implicit pass-through. That distinction could be very important in this new environment." 

Fixed-income investors can think of this as deciding between inflation-linked bonds or nominal bonds. 

Robertson says you'll want to be positioned in the first group (he nominates toll roads, airports, and European utilities as examples) rather than the second group (e.g. US utilities).

In the Australian context, Hofflin is well known (even on this website) for his outsized bet on the ASX energy sector. As recently as two weeks ago, Hofflin told my colleague (and Rules of Investing host) David Thornton that Woodside (ASX: WDS) and Santos (ASX: STO) are still two of the Lazard Select Australian Equity Fund's top five holdings. 

But he also admits it's the biggest risk.

"There is a cycle coming. If things turn out to be really bad in the US and China still has not reopened, it could be tough," Hofflin admits. 

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Lazard Defensive Australian Equity Fund

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