Value investing is generally viewed as “buying unloved companies at a discount to their intrinsic worth and waiting for their fortunes to change”. This captures a central element of the approach: price. Value investors don’t (shouldn’t) overpay.
Price is not the only concern, however. At Kennox, it is equally about quality. For us, a solid portfolio of value stocks is one comprised of sector leading companies at exceptional valuations. Price and quality are the twin pillars of our style of value investing and neither can be sacrificed at the expense of the other. When combined they provide an excellent foundation for significant upside.
Value itself, of late, has become unloved following a six year bull market. In the early stages, the recovery was broad based allowing investors of all stripes to participate. As growth and momentum took hold, the US market dominated and the beneficiaries were less wide spread. In 2015 it has narrowed further, with a handful of momentum and growth stocks continuing to drive returns while the overall US market has remained flat. As behavioural finance has taught, markets can experience periods of prolonged irrational momentum when valuations are discarded.
Value will be ‘loved’ again. As studies continue to show, value outperforms the market over the long term but patience and a steady nerve are required, as is commitment to the style.
Looking ahead to 2016 and beyond, it is evident that equity investors will need patience, commitment and steady nerves in large doses. Along with the socio-economic, political and ecological issues that will dominate, a key question at the forefront of investors’ minds will be how markets fare as the global economy extricates itself from the unprecedented monetary experiment of the last eight years. From this side of history it is impossible to tell and claims to the contrary should be viewed with a healthy dose of skepticism. The same can equally be said for energy, materials, and emerging markets – areas that will be on our radar in the coming months.
Energy has dominated much of 2015 and one would expect for this to persist well into the new year. With oil recently reaching seven year lows, stock prices across the sector have continued to suffer and it is quite possible that it could get more difficult before it gets better. For integrated oil majors the story is more positive. They have the ability to remain resilient in a world of low oil prices, as demonstrated in previous downturns. This is clearly evident in the current environment where downstream earnings are helping to offset ‘upstream’ weakness. These are world class, sector leading companies with proven track records through difficult cycles, currently available at great prices.
Gold, and specifically gold miners, will remain an area to watch. With the gold price off over 40% from its high, the industry is coming under increased pressure. Stock prices have been hit as the market has focussed on valuing profits and have mispriced assets, failing to acknowledge reserves. Major, low cost producers are well positioned, though, as higher cost producers are being forced out of the market. Coupled with falling costs in mining equipment, a lower gold price is working to the advantage of low cost producers. With the ability to survive tough conditions, these firms are in an excellent position to thrive going forward: a modest increase in the gold price could see their stocks perform extraordinarily well.
The economic downturn in emerging markets has seen equity valuations in those regions driven to depressed levels, providing potential opportunities. However, while prices have proved attractive, the calibre has not been available. With headwinds looking set to continue, emerging markets may well yet offer the right prospect which matches our demand for value: sector leading companies at excellent valuations
Six years into a bull market, 2016 could turn out to be a difficult year for equities. For the Kennox style of value, one built on price and quality, the year ahead has excellent upside potential regardless of market direction.
Charles Heenan is investment director at Kennox Asset Management