Buying the peak of gloom – rotate from growth to value

Chief Investment Officer and founder of Aitken Investment Management
Print This Post A A A

Buying the peak of gloom, when the margin of safety is in your favour, remains the hardest aspect of investing. It’s lonely being contrarian and there are many periods when you feel outright wrong. It is a true psychological test but one that, if you pass, can generate the biggest investment returns.

History lessons

I don’t particularly like going back 10 years in history, but I will today, just to make a point that leads into the view I have of market leadership going forward.

Ten years ago this week Lehman Brothers filed for bankruptcy. I remember coming to work that day in Sydney, knowing it would be a terrible day on the markets. I wasn’t wrong, there was sheer panic selling. On that day, the S&P500 fell 5%, Wells Fargo -10%, JP Morgan -10%, Goldman Sachs -12%, Morgan Stanley -14%, Bank of America -21% and, of course, Lehman Brothers -99.4%. It was a slaughter.

However, if you’d bought those stocks on the close that day, and held them until today your returns are: S&P500 +198%, JP Morgan +285%, Wells Fargo +126%, Goldman Sachs +93%, Morgan Stanley +75%, and Bank of America +21%.

It’s also worth noting tech stock returns from the day of the Lehman bankruptcy, and why perhaps today is NOT the day to buy more tech. Netflix is up 8,978%, computer game company Nvidia +3,112%, Amazon +2,447%, Apple +1,160%, Salesforce +1,050%, Adobe +621%, Microsoft +443%, and Google +444%.

This simply reminds you that you do have to act at the peak of gloom.

The question then becomes: where is the peak of gloom right now? I believe it is emerging markets and China.

Emerging markets and China

I am strongly of the view we have seen the peak of the emerging markets capitulation and the peak of Chinese equities capitulation. The opportunity set to make serious money is staring us in the face and we must act before a substantial rebound starts.

Interestingly, that recovery started this week, after President Trump confirmed a further $200 billion of tariffs on Chinese exports, initially at a 10% rate. In a classic market example of “travel and arrive”, the markets had sold and sold and sold all China facing exposure, leading into the confirmation of another round of tariffs, then bounced hard on confirmation of them at levels no worse than expected.

Markets bottom when bad news fails to trigger further price falls. This generally confirms seller exhaustion and nervous shorts. The first move up is those nervous shorts starting to cover, and what usually happens is a lack of volume on the offer on the way back up, as sellers have been exhausted. The bounces from grossly oversold, highly shorted levels can be very large.

You can see Chinese equities, global cyclicals, financials, iShares MSCI Emerging Markets (EEM) ETF, copper and even the Australian dollar have bounced hard this week. I believe this is all based around a view, and one that I agree with, that the US dollar is peaking as the US fiscal position worsens and the cost of US debt rises.

The charts 

The US dollar Index (DXY) appears to have peaked to me and this is the most important chart in markets, as it has driven huge divergence in both regional and sector returns.

US dollar strength has driven a huge outperformance of US equities versus the rest of the world. The chart below illustrates the outperformance of the US S&P500 Index (blue line) versus the MSCI All Country World Index ex USA (red line). This outperformance is historically unprecedented and represents a clear opportunity in equities outside the USA.

Similarly, the MSCI world growth index (red line) has strongly outperformed the MSCI value index (blue line). Again this outperformance gap is unprecedented.

This leads me to the very clear conclusion that now is the time to lower growth stock weightings, particularly in the USA, and buy rest of world value stocks with an Asian bias. Interestingly, just about everything China facing has become value in my view, even former growth darlings like Tencent, Alibaba, JD.COM, Baidu, Ping An Insurance, and Samsung to name a few big caps.

Tim Rocks, the respected investment strategist at Evans and Partners published a really interesting note this morning, again along the lines of what I write above. I quote below directly from Tim’s note.

Another expert view 

The market is pricing in a substantial trade war impact for Asian stocks but not for US companies, that either has supply chains through China (e.g. Apple), or sell to China (Boeing, Wynns, Nike, YUM! Brands).

The chart below compares the share price of Apple versus its main Asian suppliers (the largest assemblers are two Taiwanese listed companies Hon Hai and Pegatron).  These have typically moved together but over the past year, Apple is up 37% and its supplies are down 28%. This seems a major disconnect.


A broader list of US exporters to China (Nike, Boeing, Wynn Resorts, Qualcomm, Broadcom, Nvidia, Yum! Brands, Tiffany, Agilent) is up 28% over the past year.


If the trade war escalates, Apple and these other exporters must be vulnerable. Estimates are that Apple alone makes up $15 billion of the trade deficit between the US and China. It is vulnerable to attacks from either the US or China side. 

Alternatively, if the trade war is resolved, then the Apple assemblers (Hon Hai, Pegatron and a broader list including Compal, Quanta, Wistron) will recover some of their losses.

Another potential winner in this space if the trade war escalates is Samsung. If the Apple supply chain is affected, Samsung is the obvious beneficiary.

No growth

Samsung Electronics trades on 6.2 times consensus FY19 earnings, and offers a 3.2% dividend yield. Forecast EPS growth is 12% this year and flat next year, but on a P/E of 6.2 times, you aren’t paying for any growth.

I think the post Trump tariff sell off in the US dollar, and rally in cyclical value equities, will be sustained into year-end. I’ve warned on the momentum bubble in growth stocks, particularly tech stocks, and I think you can see the infancy of beginning of its unwind as the market rotates to cyclical value. I remain of the view the Afterpay (APT) capital raising in Australia was the bell ringing event. That stock is already 10% below that placement price.

The best value

Price is what you pay, value is what you get. It’s time to focus hard on value and the best value anywhere in the world is in China. China is being priced like it is having its Lehman moment, when the facts of the matter are it is just ridiculously cheap and oversold.

In an Australian context, this most likely means banks and resources, the two very cheap sectors of the S&P/ASX 200, will outperform everything else into year-end. Small cap industrials, which are a clear bubble, are particularly vulnerable to a rotational correction, as are technology and healthcare names.

It’s not different this time, the rubber band is too stretched.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

Also from this edition