Early market action in 2022 supports value thesis

A Market Update from Paul Moore, Founder and Chief Investment Officer

I am providing this brief update for two reasons. First, the final weeks of 2021 and the start of this year have seen important market moves that reinforce PM Capital’s investment thinking.

Second, with PM Capital quarterly fund updates due in late January, I wanted to get this information to you sooner so that you have our view on the latest market developments.

PM Capital’s long-term view is well-known. We believe a major rotation from growth to value stocks is in its infancy – and that this opportunity will play out over a typical 10-year cycle. We continue to see opportunities in value segments of the market, notably banks and commodity stocks, some of which trade at record-low relative valuations.

Conversely, many growth stocks still sell at record absolute and relative valuations. We expect growth stocks, including those in the technology sector, on aggregate to underperform value-focused sectors, such as banking, over the coming decade.

This rotation from growth to value stocks will ebb and flow. No change in market leadership is orderly. The first leg of the value rotation began in early FY21, driving strong performance. But growth stocks returned to favour in the latter part of last year as fears of the Delta Covid variant resurfaced, and as the Omicron variant emerged.

This short-lived move back to growth stocks, at the expense of value stocks, created an opportunity for PM Capital to add Airbus SE, a leading European aerospace and defence company, to the portfolio. Airbus fits our strategy of buying high-quality companies at bottom-quartile valuations.

Value regaining favour in 2022

A significant move in long-term interest rates in the last week of December and the first week of January has supported a return to value stocks this year. The US 10-Year Bond yield rose from about 1.5% in late December to 1.76% on January 7.

Rising interest rates are a bigger headwind for the growth stocks, which typically have higher relative valuations.

Other notable economic and market developments so far this year include:

  • Long-awaited signs of wages growth in the US. Average hourly earnings rose 0.6% in December and 4.7% year-on-year. This reinforces PM Capital’s thesis of rising inflation (in part due to rising wages) and higher interest rates this year and next.
  • The surge in Germany’s benchmark Bund yield towards zero. After being stubbornly negative for some time during COVID-19, the 10-year German Bond yield made a significant move to near zero in early January. Market expectations for the European Central Bank to lift interest rates are rising.
  • Potential for orderly rate rises in Europe and the US. Although US and European bond yields are rising, interest rates remain well below pre-Covid levels. This suggests rates can increase without negatively affecting global economic growth.
  • Elevated commodity prices. Some commodities are still at or near their price high, despite the slowdown in China’s economy and a strong US dollar. PM Capital’s preferred commodity theme is copper – a successful position we retain in the portfolio.>
  • Oil is cheap relative to other commodities. We’ll have more to say about this complex theme in coming months.
  • European banks remain attractively priced. In January, Lloyds Bank in the UK sold on 8 times its forward earnings. The European banking sector has excess capital and significant upside potential, amid changing interest-rate sentiment.
  • Unwinding of valuations for Total Addressable Market (TAM) stocks. The inflection in interest-rate sentiment has been negative for technology companies that have inflated valuations based on the size of their total addressable market. PM Capital has a short position in Carvana Co, an online car retailer in the US. Carvana fell 23% in the first week of January and has almost halved since its record high in mid-August 2021.

PM Capital will elaborate on these and other market developments later in January. Throughout 2022, we will provide information on our investment themes, with a particular focus on their current valuation parameters and risk/reward proposition.

Suffice to say, our long-term thesis for a decade-long rotation from growth to value stocks remains firmly intact. Market action so far this year adds to our conviction.

Although recent economic data is moving in the right direction, I reiterate that investors should expect lower annual returns in the next few years as interest rates rise. Gains from global equities since the March 2020 low are unlikely to repeat anytime soon.

That said, PM Capital has invested through many market cycles and knows what to expect. Accordingly, our guiding principles of valuation and patience have underpinned the long-term performance of the PM Capital Global Companies Fund.

I hope you find this update useful and would be delighted if you refer it to friends, family or colleagues who might benefit from this information and our investment approach.

PM Capital values your support and looks forward to helping you achieve your investment goals in 2022 and beyond.

Good investing,