Cyclical distortions appearing in the market
We are now at over 10 years of economic expansion and largely uninterrupted bull market. Economic expansions do not die of old age and most aspects of the U.S. economy still look quite healthy. The sheer length of this upswing has, however, created some strange distortions in the stock market.
Value tends to outperform in recessions as cashflow and dividends become more important. In down years, enthusiasm and excitement cannot carry a stock. Investors demand profits and stability. Normal length business cycles keep the exuberance in check, but in this 10 year+ expansion, valuations have gotten out of control in large swaths of the market. Value has materially underperformed which is in sharp contrast to stock market history where value systematically outperformed.
Is this a paradigm shift? Is value no longer the source of greater returns?
I doubt it. It would take a powerful force to break a trend that has extended centuries. Instead, I believe we are headed for a period of even greater value outperformance than historical average. The simple power of mean reversion puts value in a great place.
Value outperforms in the long run because the stocks are on-balance undervalued. After multiple years of value being out of favor, the stocks are more undervalued than normal, thereby representing greater potential for outperformance than normal. I do not know when value will come back in favor, but current pricing represents storage of a major mean reversal that will eventually pay off. It merely requires sticking with our principals and a bit of patience.
In following the markets all day, every day, it is obvious to me that value is out of favor and that value names are irrationally cheap. That being said, don’t just take my word for it. Allow me to show some examples and you can decide for yourself.
- Bitcoin sits over $5000 per coin.
- Unicorn tech IPO stocks like LYFT and soon to be UBER are given multibillion dollar valuations.
- Global marijuana sales in 2018 were $12.7B, yet Canopy Growth alone has a market cap of $16.8B. The cannabis investment universe has a massive ratio of market cap to revenues.
All of these popular investments share a common characteristic: they have zero cashflow or negative cashflow. There is something the market finds exciting about the prospect of future cashflows that have yet to materialize.
In contrast simply cashflow machines like Global Net Lease and Gladstone Commercial get overlooked. Receiving rent that is already contracted out for 10 years is not exciting. We already know with a reasonable degree of accuracy what these companies will earn in 2022.
When the market has done nothing but go up for 10 years, people tend to prefer the unknown to the known. The known cashflows are fixed and you are not going to triple your money. The unknown speculated cashflows could be anything. The fear of missing out is strong and causing predictable value stocks to be deeply undervalued.
When market prices are already distorted, it is a great time to be a value investor and 2CHYP will maintain its value focus through this period of enhanced opportunity.