About a decade ago when televised poker was in its heyday, the World Series of Poker Main Event – the final tournament of the season which included thousands of participants that each anteed up $10,000 to enter – was broadcast on ESPN. The drama played out over many weeks, with a mix of old pros, young upstarts, online players, inexperienced celebrities, and wealthy amateurs vying for the roughly $10 million first-place prize. When the tournament was finally whittled down to nine remaining players, the competition paused, to be continued at a later date in November, which allowed the proper suspense (and hype) to build. This “final table” of players was known as “The November Nine,” out of which the lucky winner would emerge.
In the fourth quarter of 2020 the November 9 Covid-19 vaccine data prompted a shift in the market on that day, as the cards were turned over on Pfizer’s/BioNtech’s candidate. The positive efficacy data led to a strong rally in lowly-valued stocks and shares of companies that had been negatively affected by the pandemic. The Russell 1000 Value Index rose by 4.1% on the day, while the Russell 1000 Growth Index declined by 1.8% - the largest one-day difference between the two on record. If you have been reading our commentaries you know that we have been positioning for this shift (“Is This a Good Time to Invest?”, “The Beat Goes On”), and we were actually a little surprised it wasn’t even more powerful. There was another profitable day for value stocks a week later when Moderna revealed its own strong hand on its vaccine. With these developments the market is sensing an economic recovery enabled by the widespread distribution of vaccines in 2021. The change in economic prospects brought on by the vaccine disproportionately benefits the lowly-valued companies, as many of the more-expensive (growth) companies saw their businesses hold up well, or even benefit, during the pandemic. This effect is amplified by the wide dispersion in valuations that we have cited. The rubber band has been stretched, and it was just a matter of time before it snapped back. Even with the strong outperformance by value stocks in the quarter (by about 5 percentage points over growth), dispersions in valuations remain relatively wide, and we believe the gap will continue to close, which should provide a nice tailwind for the value cohort. To be clear, we continue to invest with the long-term in mind.
One of the forces that has helped drive the valuations of growth stocks so high is an accommodative Federal Reserve (the "Fed"). The Fed has gone all-in; it’s not only keeping short-term interest rates low but is vowing to keep them low for a long time, which, along with its purchases of long-term government debt, has driven long rates lower as well. These low interest rates increase the present value of profits that lie far in the future, which disproportionately benefits the stocks of growth companies. There is no guarantee that rates will stay low for many years to come, but the market is pricing many of the growth stocks like they will. We believe this makes such stocks riskier than they normally are.