James Inglis-Jones

Where we see an opportunity in today’s market

James Inglis-Jones

The Cashflow Solution investment process has signalled a significant opportunity in value. This segment of the market has had an awful run of bad performance but now looks exceptionally cheap in historical context. Our indicators are telling us we need to go against the crowd as value strategies now look set to reverse this trend.


When we published our previous blog, markets had just experienced a severe bout of heavy selling. The sell-off was so brutal that it propelled our equally weighted valuation measure of markets to ‘very cheap’ levels in Europe. In markets where valuations have hit these extreme levels, historic analysis suggests that downtrends tend not to persist. Such a combination is in fact predictive of the best market returns – albeit with high volatility in returns.


Since then, equity markets have indeed recovered strongly and this has propelled our valuation metric into ‘cheap’ as opposed to ‘very cheap’ levels. Despite the recovery, markets remain in a downtrend as defined by our investment process; this combination of cheap valuations and a technical downtrend implies a more nuanced outlook for equity markets. Rather than being strongly positive, we are now more cautious in the short term but would view any retracement to ‘very cheap’ levels as an opportunity to buy.


We remain very confident in the outlook for the Cashflow Solution process against this backdrop, and we still believe that value strategies should perform exceptionally well. In some respects, these views our intertwined – our Cashflow process is attractive today for the simple reason that it is highlighting the current opportunity in many of the value stocks seen as victims of Covid-19 and hence shunned by many investors.


One way of gauging the opportunity for the process is to rank the top quintile of stocks by their cash flow characteristic and then look at how expensive these stocks are – both relative to the market and in comparison to its own history. We rank companies in our investment universe using a proprietary scoring system based on cash flow relative to operating assets and cash flow relative to market value. We then consider those stocks that rank in the top 20% for investment.


The valuation of the top quintile (Q1) of cashflow companies in our investment universe has today hit levels last seen in the tech bubble in 2000 and the global financial crisis in 2009. The below chart shows that the valuation of companies in this category is now two standard deviations below its long-term average. We find that when this top quintile of cash flow is anomalously cheap, the process usually goes on to perform exceptionally well in the next 12-24 months as valuations revert to the mean.


Current Cash Flow valuation of Q1 Europe

Source: Liontrust, Factset data as at 31.05.20.


The reason the top quintile looks so attractive is that it includes many companies from sectors seen as obvious victims of Covid-19. For example, the top quintile is heavily populated by autos, travel, financial and media stocks while health care and other defensive sectors are not well represented. Today the process is telling us that we need to be contrarian.


This is also supported by another indicator we have developed to measure investor anxiety. This looks at how worried investors are about the current growth climate. It is a contrarian measure: when investors are very worried about the future, it is a sign that there is a good opportunity in value strategies – which usually pay off exceptionally well in the subsequent 12 months. Conversely, when investors are complacent, momentum strategies are usually better rewarded.


Scrutinising the chart below gives an indication of how accurate this indicator has been in the past – calling correctly the strong performance of value strategies at the peak of the tech bubble and the opportunity in value strategies that emerged from the global financial crisis. Today – as can be seen clearly from the chart – this indicator is telling us that value strategies are likely to be well rewarded.


Investor Anxiety Europe

Source: Liontrust, Factset data as at 31.05.20.


We have repositioned the funds we manage to exploit this opportunity in value. For example, we added Danish jewellery maker Pandora, French investment bank BNP Paribas and Belgium-based steel wire transformation and coatings company Bekaert. Whilst we are benchmark agnostic, comparing the portfolio today to the MSCI Europe it’s clear we are relatively more overweight in cyclical areas than in the obvious defensive sectors such as pharmaceuticals and consumer staples. We appreciate that it may take time for these bets to pay off as the world gets to grips with Covid-19. Growth strategies – and in particular companies seen as immune or even beneficiaries – look very expensive consensus positions that we would be concerned about at this point. Value by contrast has had a poor run and looks exceptionally cheap as a strategy relative to its history – the process is telling us its time may have come.



Liontrust Insights


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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Cashflow Solution team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Liontrust European Growth Fund holds a concentrated portfolio of stocks, if the price of one of these stocks should move significantly, this may have a notable effect on the value of the respective portfolio. The Liontrust Global Income Fund's expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, June 25, 2020, 11:43 AM