Given the ever increasing dominance of macro factors in market moves, we thought it worth continuing with the observations made in our blog earlier this summer.

“The greatest trick the Devil ever pulled was convincing the world he didn’t exist” is an oft-quoted line from 1995 cult film, The Usual Suspects. The same could be said for equity investors when it comes to factors.

Many investors pride themselves on picking stocks solely based on fundamentals rather than near-impossible to forecast macroeconomic inputs like inflation, the price of oil or European gas futures. In truth, it is not a bad rule of thumb. In our experience, a good company with solid fundamentals and, crucially, an attractive valuation will tend to perform well in the medium to long term, regardless of macroeconomic data.

We are agnostic both when it comes to the sectors we invest in – only avoiding biotech and insurance mostly – and in terms of style, whether it be value, growth, momentum or quality. After all, a growth stock today could quickly transform into a value stock in a sell-off or if its fundamentals catch up with its price. Equally, a stock can simultaneously share different factor characteristics – such as both a high FCF yield (value) and strong top line growth – so it would be irrational of us to be exclusively long or short stocks because of a classification by some clever statisticians (or, increasingly, an index creator).

However, there are periods when it is pretty risky to ignore factors. There have been only three periods in the past 50 years. During the Nifty Fifty era in 1973, it cost investors dearly, as it did during the dot-com bubble in 1999 and, of late, during the “everything bubble” that swept during the Covid-19 pandemic.

The data below depicts the relative valuation over the past half century of value versus growth stocks in Europe. Most of the time, they’ve tended to perform in line with one another, leaving investors to focus on the bread and butter work of analysing companies.

However, with the spread between these two factors back at the levels of 1975 and 1999, the risks to investors unwittingly caught on the wrong side of this trade seems high.

On a returns basis, the dispersion is even more extreme. According to Stifel, this is only the third time since December 1939 that the rolling 10-year compounded returns of these two factors has reached this level.

Going on history alone, we doubt this can remain the case for much longer.

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