The Baggot Equity Portfolio has had a good start to the year. As of today, (March 2) it  has  gained  14%  YTD.  The  Nasdaq  100  which  is  chock  full  of  growth  stocks  that trade at gaudy valuations, is down 12% YTD in Euro-denominated terms. That is 26% out-performance of the Nasdaq 100, the gaudiest of growth proxies. To be fair our benchmark for this product is the MSCI World Index, which is currently down 7% YTD. Still an out-performance of 21%.

Last year I wrote a piece about how value investing as it is generally defined, had outperformed growth investing as it is generally defined, by 110%, during the period historically known as the ‘Tech Wreck’ (See Link above)

A period of roughly 18 months beginning at what was at the time, the all-time high for the Nasdaq 100, in March 2000, and ending at the bear market low in October 2002. By the time the top of the bull market went in, in late 2007, it had outperformed the Nasdaq 100 by more than 290%.

I ended the piece stating that most people would be surprised by this for one of two reasons,  either  you  are  too  young  to  remember,  which  means  you  are  unlikely  to believe in value investing, or, you do remember it but you don’t remember enjoying decent  returns  during  that  18  month  period  because  most  of  your  investment exposure (pensions, etc) was in the areas that performed the worst.

We  aren’t  solely  value  investors  at  Baggot  Investment  Partners.  We  are  happy  to own growth stocks as long as they trade at reasonable valuations relative to their growth rates. What we refuse to do though, is to invest in growth stocks at any price because we liken that to trying to pick up a penny in front of a steamroller.

When you invest in stocks at stupid valuations, as Warren Buffet once told us, you find out who is swimming naked once the tide goes out. A perfect example is Facebook  (now  known  as  Meta).  It  has  lost  45%  of  its  value  since  its  highs  in September last year and in early February on the back of a worse than expected earnings report, it dropped 26% in one day!

I  am  not  saying  things  can’t  go  wrong  for  a  value  investor,  but  when  you  pay  4x earnings for a stock that has a solid balance sheet and low debt levels, not to mention a double digit dividend yield, as we did in November of last year with Impala  Platinum….  Well  if  something  does  go  wrong,  it  is  much  less  likely  to  drop significantly  in  price,  because  there  is  a  much  higher  margin  of  safety  discounted into the stock price. Consequently, our Impala Platinum position is up 35% since then and still trading at a cheap valuation.

In true bull markets, stocks like Facebook don’t drop 26% on an earnings ‘miss’ in one day. It is a sign of the times. We believe the bull market is over for the major western stock indices for two reasons. First, the technical behaviour of the market has changed from one that tests and holds rising major moving averages (we are using the 100 day moving avg for this example) to one that tests and fails to get above falling major moving averages.

The second reason is Inflation. If you thought the Covid period of the last two years stoked  inflation  you  haven’t  seen  anything  yet.  War  trumps  everything  in  terms  of generating inflation. Inflation means much higher interest rates will be discounted by the market. This is bad for stocks traditionally known as growth stocks. Higher interest rates means you can’t discount growth so far into the future, so valuations, and  therefore  prices,  have  to  come  down  and  it  is  a  long  way  down  from  current levels!

What is interesting this time around, is that this stock market bubble is concentrated to a relatively small group of mega-cap stocks that make up the majority of the stock indices due to their sheer size and scale. This means there is ample opportunity  in  stocks  that  aren’t  trading  at  stupid  valuations,  which  have  decent balance sheets, reasonable debt levels and throw off decent free-cash flows.

Kind Regards, David Flynn

Chief Investment Strategist and Director dflynn@baggot.ie