Ideas Farm: Rejoice, the Dash for Trash is here!

The chart below shows the performance of the investment styles we monitor over three months, one month, two weeks and one week. While ‘value’ continues to be the loser over three months, over shorter timeframes it leaves all other investment approaches in the dust (‘value’ in the chart represents the average performance of strategies based on backing the cheapest fifth of FTSE All-Share stocks based on: forward price/earnings ratio; price to sales; price to book value; dividend yield; and enterprise value to cash profits). In fact, while the outperformance of ‘value’ looks dramatic over the past month as a whole, for the first two weeks of the month it was actually underperforming the other styles, although it was outperforming the index. In other words, the dramatic recent win for value has really happened within the past two weeks, and the lion’s share of that outperformance appears to have come in the past week. 

It may feel an odd time for value to outperform. Value stocks tend to reflect the inherent weakness of the company that has issued the shares. This often boils down to things such as high debt and significant ‘cyclicality’ (City jargon to describe a company with profits that are very sensitive to economic conditions). It seems strange that these stocks should outperform as the world enters a deep recession.

However, a ‘dash for trash’ is a classic phenomenon when stock markets rebound, which in turn typically happens before any clear signs of an economic recovery have emerged. Indeed, stock markets tend to move in anticipation of events that are furthest from sight rather than those that are readily apparent. 

The ‘dash for trash’ can be seen as another sign that the huge policy response – fiscal and monetary – to the economic impact of coronavirus is being viewed favourably by investors. Importantly, the dash for trash can be regarded as more of a judgement on the economic outlook than a reaction to the increased liquidity provided by central banks. This is because there is a logic to thinking increased liquidity will boost demand for shares in the biggest and safest companies, while investors that want to benefit from an economic recovery will buy shares in companies that have the most to gain from an upturn – the weakest companies with the most beaten-up shares.

Naturally, this move by the market could prove premature. The Covid-induced recession could be longer and more painful than those piling into cheap stocks expect. There are also signs of very speculative punts being taken. But a dash for trash is always a highly speculative phenomenon. This means it takes a bold investor to jump on the bandwagon. Indeed, the psychological difficulties of switching investment style mean most investors are best advised to stick with the style wagon they are already on. More generally, the dash for trash can be regarded as a broadly encouraging sign, given it is a key initial stage in most stock market recoveries. That said, there are still plenty of reasons to remain cynical and wary of bull traps (recoveries that suck in money before blowing up). 

Three of the shares appearing in this week’s tips section come from the ‘trashier’ end of the spectrum. All could see their businesses benefit significantly from a recovery. For upholstery retailer DFS (DFS), not only could an economic revival mean a recovery in demand, but it should also face less competition as weaker rivals fall by the wayside. M&G (MNG), meanwhile, should benefit from any continued market strength and this could make potential value on offer from its unexciting business become more apparent. Finally, BHP’s (BHP) profits are highly sensitive to the price of iron ore and copper, both of which have their fortunes closely wed to the state of the global economy. Encouraging signs from China makes this an interesting time for the company.

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Source: S&P Capital IQ

Source: S&P Capital IQ

Source: FCA

Source: S&P Capital IQ

Source: S&P Capital IQ

Click here to view the tables in PDF form