Among those expressing concern is veteran fund manager Neil Woodford, who is widely reported to have suggested that equity markets are in bubble territory. Looking past the headlines, what Mr Woodford is worried about is the gulf between the performance and valuations of growth and value shares, which he notes is at its widest level ever, and the high prices being demanded for shares in companies felt to be resilient to possible economic headwinds to come. Animal spirits, he says, have taken over as the primary driver of share prices, an argument also recently espoused by veteran investor Luke Johnson; the Pizza Express and Patisserie Valerie founder argues that, in the current cheap money environment, “fundamentals are dead as a tool for investors” which means capital misallocation “on an unprecedented scale”.
Mr Woodford has been accused by some cynics of talking his own book, perhaps a reflection that his star has fallen somewhat after a recent mistake or two. But we share his view – like Messrs Woodford and Johnson we too are concerned that valuation discipline has slipped from many investors' processes, and are disappointed that value strategies are still yet to recover ground against more speculative growth investment.
But as Mr Woodford says, while elevated markets can bring danger, they also bring opportunity. As markets have risen, some shares, often those displaying what we’d consider value characteristics, have remained stuck at base camp. Many of those operate in sectors exposed to the weakening UK economy: retail, aerospace and defence, and support services. Of course, wariness of value-type shares is not without foundation, as a raft of recent profit warnings have demonstrated. But like Mr Woodford, I believe that it’s in those unloved areas of the market that future gains are most likely to be found, rather than those already flirting with the market’s stratosphere.
Take retail as a notable example. The sector is being battered by economic and industry pressures, in many instances the presence of online challengers such as Amazon. But traditional retailers are in many cases priced for terminal decline, while Amazon, as an example, is being priced for world domination – its shares trade at an eye-watering forecast PE of 270; Sainsbury, a long-established UK retailer with a strong foothold in ecommerce after its takeover of Argos, trades on just 13. The reality – as is so often the case in markets – is likely to lie somewhere in the middle – just look at Findel, where a recovery few expected is taking place. It could soon be time for contrarians to shine.
