With the end of Quantitative Easing in the US, money is no longer 'free' as interest rates rise again. The choice before was invest in a growth company of let your savings whither away in your bank account. Now there is more competition again for capital.
Back in December 2014 we said, “don’t fight the Fed” and this applies just as much now as it did then. But unlike just over two years ago, it’s working against so-called “growth” stocks and for the “value” end of the market.
In late 2015 the US Federal Reserve was still in the midst of its quantitative easing policy in which it is estimated it accumulated some US$4.5 trillion (A$6 trillion) in assets in order to encourage spending. “When the Fed’s monetary taps are on, the market will keep going, and this includes big and small caps,” we wrote. The market had corrected 10 per cent the previous October and had quickly reversed that in a V shaped recovery.
But QE ended in October 2015 and as of last December the Fed embarked upon a reversal of that process by raising interest rates, albeit from very low levels.
The game has changed, but the dictum applies. What does this mean for investors?
Competition for Capital
First of the bat, it means that any corrections will not be so quickly reversed. Investors are no longer playing with the concept of free money. The choice before was invest in a growth company or let your savings whither away in your bank account. Now that interest rates are rising there is more competition for capital.
What is a growth stock?
A “growth” stock is one whose earnings grow at a steady or accelerating rate. As soon as growth starts slowing growth, the story comes under question. Post the Fed’s decision to start hiking interest rates, investors are now much more sceptical of so-called growth stories.
These, by definition, include the big caps of this world because growth stocks grow large very quickly. Momentum is with them as they get bigger and the rest get forgotten. But these companies are now in the firing line if they don't measure up to almost impossible to meet expectations. Take the sharp sell off in the sports apparel giant Nike Inc. (NYSE:NKE) last week after missing revenue expectations, but more pertinently, look at the poor share price performance since December of all but one of the FANG crew (Facebook, Apple, Netflix and Google).
Then there is that recent ASX listed phenomenon, the organic baby formula marker Bellamy’s (BAL), whose stock has skyrocketed from its $1 listing price in August 2014 to as high as $16.50 in mid-December. Its shares are now trading a third lower, but at just over $10 it still has a market cap of over $1 billion. For a stock like Bellamy’s to trade at its current level it relies upon not just super sales growth, but also growing profit margins. In its last result investors saw that the latter couldn’t be assumed, and sold stock.
What about value?Value can occur in many forms: cheap relative to earnings or to assets or to prospects. Whereas in “growth” you’re paying up for the future; in a “value” scenario” you’re paying nothing. You’re getting the future for free if the present can work itself out.
Cabcharge a good example of a value companyEarlier this month I wrote about Cabcharge (CAB), which is a good example of a value company. Its future is being discounted to zero because of the hype surrounding the global ride sharing business, Uber. In the present, it has to deal with a state imposed 50% reduction in its network services fee. I reasoned that because it remains a dominant player in Australia Cabcharge can work through this setback and continue to deliver strong dividends to investors. In contrast Uber’s US$62.5bn valuation is predicated on it getting 40% market share globally.
Cabcharge’s shares have rallied in the short time since that article, which gives you another indication that investors are favouring value over growth.
From the column published in The Australian, Tuesday, March 29, 2016