Manager Commentary, 1st Quarter 2019
LAND OF THE UNICORNS
There is a herd of unicorns prancing through Wall Street and the bulk of money is chasing them. A “unicorn” refers to a startup, usually venture-backed, that achieves a private valuation in excess of $1 billion whether they are profitable or not when they become public. What once seemed impossible is commonplace today. The two king unicorns are Uber, the $1.8 billion money losing taxi company, which could go public next month with a value of $120 billion, and Lyft, who lost $911 million in 2018 and had a valuation of $20 billion upon their offering.
The estimate for upcoming offerings in 2019 is $80 billion which is double the yearly average since 1999. Historically, peaks in IPOs have indicated the top of the stock market and a precursor to recession. Both 1999 and 2007 were very strong years for IPOs leading to nasty bear markets thereafter.
The proportion of companies reporting losses before going public in the U.S. is the highest since the dot com boom in 2000. Of the companies that went public in 2018, +80% of them were unprofitable. And of the 100+ companies to complete an IPO since 2010, 64% were unprofitable. As can be seen from the chart below, the Russell 2000 loss-making companies outperformed profitable ones by more than 600 basis points (bps) in the first half of 2018 and are doing so by more than 700 bps so far in 2019. The unprofitable companies in the Russell Microcap Index outperformed the profitable ones by 420 bps.
Back to the Future…1Q19 Performance Mirrored 1H18
Loss-Makers surged again in 1Q, with Biotech and Software leading the way
Loss-making companies in the Russell 2000 are Outperforming in ’19 as they did in 1H’18
Source: Furey Research Partners and FactSet.
There is a great amount of money going into these IPO stocks leaving little for the rest of the market. Investors are dumping shares of established, profitable companies to buy these new stocks. The question being asked is if value investing is dead. Since 2010 with the start of quantitative easing and its impact on the yield curve, we have seen growth companies have an advantage over value. This has been the longest, broadest period of loose monetary policy and consequently the longest period of underperformance by value stocks. In the first quarter of 2019 alone the Russell 2000 Growth Index rose 17.14%, or 521 bps better than the Russell 2000 Value Index which gained 11.93%. Value stocks have beat growth stocks by 4% each year between 1926-2008, but growth stocks are currently enjoying their longest rally on record, having been the place to be ever since global stock markets bottomed out in early 2009. The chart below gives a better picture of how long growth has been outperforming value in this current period. While we clearly don’t know when the tide will turn for value, it seems clear to us that we are closer to the end of growth’s dominance than the beginning.
Growth Has Outperformed Value Six Times Since 1945
Each Time Value Has Had A Significant Recovery*
All performance information is hypothetical and not the actual performance of an investment fund. Historical performance is not necessarily indicative of future performance. The data used in this study is publicly available and can be accessed at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
* Data from Kenneth French, the Fama/French benchmark. Portfolios are rebalanced quarterly using two independent sorts, on size (market equity, ME) and book-to-market (the ratio of book equity to market equity, (BE/ME). The size breakpoint (which determines the buy range for the Small and Big portfolios) is the median NYSE market equity. The BE/ME breakpoints (which determine the buy range for the Growth, Neutral, and Value portfolios) are the 30th and 70th NYSE percentiles.
Despite the Strong Quarter, Relative Valuation Remains Compelling
Relative to large-caps, small caps appear increasingly attractive
Source: Furey Research Partners and FactSet. Data as of 1/29/19.
Represents median P/E using latest available 12-month earnings.