Schroders: Three reasons why the tide may have turned on long/short investing

First, economic and equity markets returning to a more normal state should allow for greater dispersion in share prices, with company-specific factors becoming relatively more important to driving share prices.

Second, the below-average spread in the market valuation between value and growth stocks should be a tailwind to both long and short opportunities.

Third, increased stability in more European and emerging market economies is opening up a broader opportunity set.

Here, we dig a little deeper into these three reasons.

1. Back to normal?

We believe that the extended period in which there has been an elevated systemic risk of a global deflationary spiral is at long last behind us. This could increase dispersion of stocks in general and the spread between the longs and shorts.

The Federal Reserve (Fed) began raising interest rates in December 2015, with the view that the US economy was strong enough to return to more normal levels. But, in a globally interconnected economy, weakness elsewhere led to volatility in financial markets.

The favourable reaction in financial markets to the Fed raising interest rates twice and guiding the market toward further increases is a key indicator that the global economy is more stable.

We believe this is a significant development for fundamentally-based bottom-up strategies where stock selection is predicated on dispersion in share prices, driven by differences in the performance of individual businesses.

Since 2008, we have been investing in a market in which the economic outlook has been much more important than it had been historically. Share prices have been driven more by changes in valuation multiples than by changes in earnings.

We anticipate a market in which company-specific factors including earnings and cashflow return to their historical levels of driving share performance. We believe a more idiosyncratic environment can support a widening spread between long and short opportunities. 

2. Favourable valuations

The fourth quarter of 2016 capped an historic market rotation towards value-style stocks and away from growth stocks.

The result has been a reversal in valuations, with value stocks now relatively expensive, while growth stocks are now relatively cheap.

In addition, the dispersion in stock valuations is below average. Widening back to historical levels should be an additional tailwind.

3. Expanded global opportunity set

More markets around the world are returning to a degree of normality, which is increasing the global opportunity set.

Equity and credit markets in Europe and emerging markets have responded favourably following the Fed raising interest rates, in sharp contrast to a year ago, indicating the greater stability of their economies.

With less of the world impacted by macroeconomic concerns, we expect a wider range of options for selecting stocks

We continue to find an abundance of opportunities in the US based on our bottom-up research process despite the rise in valuations for the US market as a whole.

We see a better-than-usual opportunity to earn a positive spread between our longs and our shorts, with expectations and valuations in the US market historically high for lower quality businesses and relative valuations historically low for faster growing business.

Lower valuations in Europe and emerging markets relative to the US are increasing the appeal of certain long opportunities.

We have a wide range of investments outside of the US, both long and short, in businesses that are part of a global investment theme, have company-specific competitive advantage or disadvantage, or are experiencing a boom or bust in their industry.

Dieser Artikel ist am 19.07.17 auf schroders.com erschienen.