The start of every quarter is dominated by earnings calls made by companies who have looked through their previous quarter’s results and then make predictions for future quarters.

Some of these calls get more airtime than others, especially for the largest companies in the US due to their prominence in investors’ portfolios.

Over the past few years these calls have become a pivotal driver of short-term market movements and sentiment, and even more so this year, as investors continue to focus on whether a slowdown is going to occur and the impact this will have on their investments moving forward.

This week has seen a slew of earnings calls from the largest technology companies in the US. Investors were hopeful that Amazon, Meta and Alphabet would perform in line with analyst estimates, as the services provided by these companies are described by some as ‘recession proof’ due to their brand power and dominance in their markets.

Many of these large technology companies reported they had missed their earnings calls and sharp sell offs in the stock price occurred after the releases. We think that the movements in share price are highlighting something very important for investors; the price that you pay for an investment has become much more important recently, especially as macroeconomic factors are becoming more opaque over time.

Between 2010-2020, fiscal and monetary economic conditions were extremely loose, with zero interest rates, quantitative easing measures, low inflation, and low growth. This meant investors could pay a higher price for shares without the risks that are currently present. These macro- economic conditions are changing and leading to a shift in the prospects for business over time.

We have found within the past few quarterly earnings releases many of the cyclical and value- based companies have beaten earnings expectations and performed better than analysts predicted, in direct contrast with their growth counterparts. The market has been more favourable to these value sectors and the share prices have been reacting positively to the earnings figures released. Companies that have been missing their earnings, such as some of the big technology companies, have been hit hard. There is a big divergence in the outcomes for stocks dependant on their outlook. This is something we believe will continue which is why we favour businesses within value sectors including financials, energy, and industrials.

Why valuations matter

The price you pay for an investment is extremely important as it impacts its future return.

The investment team have previously been allocating more to value-based investments as we believed that growth as an investment style would underperform, as the valuations of many growth companies were too high.

When other investors were still focusing on what had dominated markets during the 2010s, we had highlighted the opportunity to invest in stocks that we thought would perform better in a changing global economy. Even now, many investors continue to ignore the opportunity presenting itself in some of the better value-based sectors that have the potential to continue to outperform over time.

This has started to play out over the past two years as the graph below highlights, and we believe this has still got further to run.

Source: FE Analytics October 2022

Has the recent sell off provided opportunities in more growth style stocks?

The selloff over the past year has helped reduce the premium on valuations of many growth stocks. However, we think this has got further to run for some companies. The chart below shows that the recent outperformance of the value style hasn’t really made any inroads to reducing the gap between growth and value. Investing in growth did work over the past decade and investors made money from this. We believe this is now changing. Value compared to growth is still at a large discount. Even if this discount shortened to its average level that would lead to a large outperformance of value compared to growth for several years.

Source: Schroders September 2022

Over the past year, many of the growth stocks have sold off. Within many of these investments, the stock price has fallen but the forecasted earnings haven’t fallen and are still positive. We believe this is something that some of these companies cannot deliver. Therefore, further valuation compression is needed. Large cap names such as Amazon are being hit hard from earnings misses as it hasn’t been priced into the stock yet. More of this could occur in these growth stocks where future earnings haven’t come down enough.

A lot of the value and cyclical markets that we are currently overweight to, have had their earnings reprice already, and have also had valuation reductions from a price perspective. This has meant that many stocks are now at prices not seen for several years. This makes them even better investment prospects now than they were before.

Selection is key

Not all growth stocks are overpriced, and some haven fallen to levels which the active managers utilised within our portfolios, are starting to purchase. Some of the very deep value names within the global stock market are cheap for a reason, and even though they have reduced further, we believe they are still not good investments for the long term. Being selective is key.

Overall, though, we still think that the market is ignoring many of the best value-based stocks, that are more cyclical in nature and have been unloved for years. These stocks are providing positive earnings uplifts for investors and their already cheap valuations are providing great upside potential over time. Therefore, we are currently overweight to value investments within our portfolios. We still hold some growth investments but are extremely cognisant of the price and quality of these businesses, as we do not want to be invested in areas where further valuation compression is to come.

In Conclusion

Valuations need to reflect the future and the economic slowdown that will likely be occurring over time. We continue to focus on the fact that what has worked in the past, may not work in the future. We are moving into a ‘new normal’ economic cycle where you cannot just buy any stock at any price and hope that it will increase in value. The underlying economic conditions are going to be tougher and therefore the price you pay for stocks will be key for the potential returns that are available over time. We are focusing on these principles with the funds we are holding.

The team continue to invest in both growth and value styles, with an overweight to value. As market conditions continue to be volatile, we believe utilising a diversified multi asset portfolio will provide investors with the best long-term opportunities.