Are conscientious value managers heading for another dark night of the soul, such as the one that played out after the crises of 1998? It is not impossible. “I have that sinking feeling,” one such fund manager, a former associate of Sir John Templeton, recently confided. “We know what could be coming – and it is not going to be fun. We are going to get crucified on relative performance if this goes on, just as we were in 1999.”
What he means is that fund managers whose addiction to value as an investment methodology is more than skin-deep face the real possibility that global equity markets will now shrug off the credit crunch and embark on a final blow-off phase of bullishness. This could culminate in a spectacular meltdown – but not before the performance of their prudently managed funds has hit the bottom quartiles of the performance tables.
The way emerging markets have performed since the middle of August strongly suggests this is a more than plausible outcome, in spite of the risks that the fallout from the credit crisis will be severe. As often happens in markets, value and momentum have seemed to be on a collision course for weeks, while bond and equity markets are operating as parallel universes, discounting two quite different outcomes.
It is hard to recall a period, other than 1998-2000, when opinion about the future direction of markets has been so polarised. At one extreme is a Scottish investment trust whose pessimism has driven it to adopt a position of 100 per cent liquidity – surely some sort of record, even for Edinburgh. At the other sit the pundits who argue, with bank credit analysts and others, that what we are seeing is the classic market response to a reflationary move by the Federal Reserve. Even though some sort of economic crisis may be inevitable in the medium term, so this argument goes, equities could have a long way to run before the present cycle reaches a peak. If emerging markets turn out to be a new mania, as some suspect, we may not be more than halfway through the final phase.
For value investors who fail to ride this cycle, the risk is of being left behind – so far behind, in the worst case, that their business models will be at risk, just as it was for many firms who failed to “get it” in the crazy final stages of the internet bubble. For technology stocks then, read emerging markets now. For credit “crisis” this summer, substitute buying “opportunity” today.
The best value investors have sterling qualities – among them, a belief in reason and the wisdom of experience – that serve their clients well in almost every market condition except a late-stage bull market. Their misfortune is to know from reading market history that the timing of market downturns cannot be predicted, even if with hindsight they will appear to have been inevitable.
What the histories of financial markets show is that many preconditions for a blow-off market are now in place – low real interest rates, a crisis that needs to be contained, persistent amnesia about risk, and plausible reasons for believing markets are cheap. The story driving emerging markets to new highs is the perceived ability of Asia and Latin America to generate their own growth momentum.
The tragedy for all true disciples of value is to be condemned to miss a final Gadarene rush into risk assets. “You can ride the tiger with your own money, if you must,” says my value investor friend. “But you cannot in all conscience do it with institutional money.”
Where, and how, will the market surge end? In the short term no one knows. No bull market has ever been brought to an end by the application of reason alone. Although emerging markets were becoming over-bought, the pattern of trading since the credit crisis emerged still offers more comfort to the bulls than to those who think, like Jeremy Grantham of GMO, that what we are watching is a “slow-motion train crash”.
Yet it has never been wrong to take advantage of one side effect of turbulent markets, which is that some outstanding fund managers find themselves languishing out of favour. In 1987 you could have bought a closed-end version of the Templeton Growth Fund on a 40 per cent discount to net asset value and, in 1998, the investment trust version of Anthony Bolton’s Special Situations fund at a 25 per cent discount. If the global bull market continues on to excess, leaving value investors behind, such opportunities will surely come around again.
The writer is a journalist and author of Investing with Anthony Bolton
Inside Curve returns next week