Where is the value?

Taking stock of our portfolios at the start of 2018, we believe equities remain more attractive than bonds and cash but are wary of complacency as the bull market stretches into a ninth year.

We continue to look to buy favoured areas when they are cheap and have recently tilted our multi-asset portfolios towards value stocks, where performance remains far below surging growth companies.

With such a backdrop in mind, we continue to look to buy favoured areas when they are cheap and have recently tilted our multi-asset portfolios towards value stocks, where performance remains far below surging growth companies. We see this as a broad trend, most obvious in the US, but also prevalent across Europe, Japan and emerging markets.

Value investing has a long-term track record – championed by the likes of Benjamin Graham back in the 1930s and Warren Buffett – but followers of this strategy have suffered a lost decade since the end of the financial crisis.

As a contrarian approach by nature, value often endures difficult periods, most notably during the tech bubble of the late 1990s. But the current malaise has been so prolonged that Goldman Sachs' research recently debated whether value investing is effectively dead.

Thankfully, for its many followers around the world, the investment bank concluded it is too early to give up on value and current 'unfriendly' conditions are unlikely to persist.

Elsewhere, renowned US hedge fund manager David Einhorn from Greenlight Capital, another value acolyte, has also contemplated in recent months whether his favoured strategy might never return to favour.

Writing to investors in October, Einhorn stressed his view that the value cycle will turn 'when it turns' but also considered an alternative option in which the market has adopted an alternative paradigm.

"What if equity value has nothing to do with current or future profits and instead is derived from a company's ability to be disruptive, to provide social change or to advance new beneficial technologies, even when doing so results in current and future economic loss?" he asked. Anyone watching the rise of Facebook and friends in recent years would admit this has often seemed the case.

For our part, we point to several signals as to why 2018 may be a good time to increase exposure to the cheaper value end of the market. But as many commentators, including us, were also talking up the opportunity at the start of 2017, investors can justifiably ask what is different now.

Thankfully, for its many followers around the world, the investment bank concluded it is too early to give up on value and current 'unfriendly' conditions are unlikely to persist.

Strong performance from growth stocks since the financial crisis is understandable, with investors willing to pay for companies able to outgrow a sluggish global economy. According to Goldmans, ongoing 'secular stagnation' has clearly inspired investors to favour stocks capable of generating their own growth over value names.

This has supported the FANG companies (Facebook, Amazon, Netflix and Google) and many others, whereas financial stocks – a bastion of value as much as technology is of growth – have spent the last decade weighed down by ever-increasing regulation.

Value began to rally in 2016 and into 2017 after central banks appeared to be stepping away from austerity, realising monetary stimulus had reached the end of the road and governments needed to stimulate economic growth. This recovery faltered however as President Trump's earlier policy initiatives – including healthcare reform – stalled and little progress was apparent in areas such as infrastructure.

Particularly in the US, the gap between growth and value has now reached historic levels and we see a solid case for this starting to unwind in the shape of Trump's tax cuts. Wherever you stand on these politically, consensus suggests the positives for corporations and individuals could boost many sectors of the economy in 2018 and if Trump continues his deregulation plans, financials look to be an obvious beneficiary.

Value stocks tend to outperform when economic expansion is broad-based and relatively robust – generally at the start of a cycle – and there are signs we may be coming out of the sluggish growth of recent years.

We are currently in a rare situation in terms of the global economy, with all 45 countries tracked by the Organisation for Economic Cooperation and Development (OECD) on pace to register growth in 2017 (final figures will be released in due course) and 33 of these accelerating from 2016.

High-flying growth stocks have posted earnings that do not necessarily match their expensive valuations and, at some point, investors will want to see a closer relationship between the two.

This is the first time since 2007 that all of these countries are growing in sync and the most countries in acceleration since 2010, when many enjoyed a fleeting bounce from the global financial crisis. In the past 50 years, such simultaneous growth has been rare: apart from 2007, it only happened in the late 1980s and for a few years before the 1973 oil crisis.

Something else to bear in mind is that high-flying growth stocks have posted earnings that do not necessarily match their expensive valuations and, at some point, investors will want to see a closer relationship between the two. Whispers of another tech bubble remain muted for now but in an environment where earnings matter more than future prospects, value names come to the fore.

A final driver for value is the relative downside protection these fundamentally cheap stocks can offer after a decade out of favour. While no one is ever keen for a downturn, we were not surprised to see the February correction in markets. We are not expecting a prolonged bear period, which is typically preceded by economic recession, but given their strong run, growth stocks will likely bear the brunt of any selloffs and we are watching current events with interest.