Since the start of February, cyclical stocks have performed much worse than the wider market as many investors have become concerned that rising interest rates and high energy prices will lead to an economic slowdown or possibly a recession. More defensive sectors such as utilities and consumer staples have been amongst the best performers whilst cyclical sectors such as consumer discretionary and materials have been the worst.
In last few weeks, however, we have started to see signs of real capitulation as some investors have begun redeeming funds that are exposed to cyclical value after many of the stocks they own have already halved in value in five months and now trade at mid-single digit price to earning multiples.
As a wise investor said to me many years ago “If you are going to panic, panic early” and selling cyclicals now feels too late to us. Indeed, as contrarians, we would argue that now is the time to buy these stocks but for anyone still thinking about switching from cyclicals to defensives, we would urge them to ask themselves the following questions:
- How reliable are your own economic forecasts (be honest with yourself here)?
- Is the recession already priced in?
- Should you sell cyclicals at the top or bottom of an economic cycle?
- Are you an investor or a speculator?
- How do you feel about doing what everyone else is doing but later?
- What does the gap in valuation between cyclicals and defensives look like right now?
- Does buying lowly valued stocks improve or reduce the chances of making satisfactory long run returns?
Rather than form a long-term view of the valuation of many businesses quoted in the stock market, and take advantage of the fact that the recent panic has created an opportunity to buy them for less than they are potentially worth, it seems that many are allowing price action to influence their own behaviour.
The institutional imperative, and a desire not to look too different from ones competitors, seems to be driving many investment decisions rather than a desire to take the best course of action for underlying investors. Many asset allocators seem incapable of stomaching any fluctuations in a company’s profitability or volatility in share prices and therefore stability, which is much sought after, has become over-valued whilst volatility is undervalued. Since we are not unduly concerned about variation in short term profits nor share price volatility, we regard this as a very attractive investment opportunity.
The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values. We realise that this course of action is unlikely to be popular in the short term and that articulating an investment strategy of buying ‘wonderful businesses’ is the easier route to asset raising, but the fact that we have always been willing to go contrary to perceived wisdom has been one of the key reasons behind our long-term returns. We see no reason why that should change now.
Ian Lance is co-head of the UK Value & Income Team at Redwheel and also co-manager of the Temple Bar Investment Trust
