The world seems an increasingly uncomfortable place for traditional stock and bond investments. Despite dramatic repricing (with the MSCI ACWI down 26% and the Bloomberg U.S. Aggregate Index down 15% YTD through 9/30/22), there is little optimism that the carnage is over.
We have long said that valuations are stretched and that investors should be cautious when it comes to their level of exposure to market beta. One of the reasons that we remain excited about the long Value vs. short Growth trade is the fact that it is broadly equity beta neutral – a very desirable characteristic in this time of heightened uncertainty. It has been an oasis of positive performance so far in 2022. 1 The GMO Equity Dislocation Strategy is our active, risk-controlled approach to exploiting the Value-Growth opportunity. The Strategy is long the cheapest Value stocks and short the most expensive Growth stocks, and it is approximately beta neutral.
To hypothesize on the future success of this trade, it is interesting to consider the potential drivers of relative performance.
Interest rates: No clear link to Value relative performance
A narrative of low rates justifying high valuations for supposedly longer-duration Growth stocks seems to have been a force behind Growth stocks hitting bubble levels. However, we do not believe there is an underlying fundamental connection 2 and historically there was little correlation (see chart below). If the Market latches onto a narrative, investor sentiment and behavior can render it self-fulfilling in the short term; witness the recent dramatic rise in the correlation between yield changes and Value performance. While higher inflation (and rates) began the unwind of the Value-Growth gap, our expectations for the future of the Value trade remain grounded in fundamentals and therefore are not predicated on any particular path for rates.
Continue reading with charts here.
