I know the orthodoxy here is indexing everything, but I'm wired as a value guy, always have been, and I thought you might like this post I put on my blog in August. I think its very relevant today.
No one seems to talk about value anymore, I mostly hear people talk about the future growth potential of companies. Then again, those who have cared about valuations have spent the last year having their nut sack nailed to a wall, so I cannot fault value nerds for abandoning the true religion to now pay 40 times revenue for unprofitable growth. There’s a powerful incentive to ignore facts and go with what’s working and value investing clearly hasn't been working.
I don't disagree that some of these asset light companies are great businesses - almost always superior to a capital-intensive industrial business and for that matter, a branded industrial business is still preferable to a capital-intensive commodity business with volatile pricing. I think most intuitively understand this. However there is a price for everything and as more and more capital concentrates on the “best businesses,” amplified by indexing the rest of the market has collapsed to valuations that are insane.
In the thirty years I’ve been reading investor letters, I would argue that the valuation gap has never been this large. Even in 2000 when there was a massive gap, it was not 2020 big. During the growth correction that followed growth collapsed 3000 basis points relative to value.
I don’t know when, but there will be a massive re-allocation at some point and capital will flee from the high flyers and into the more mundane businesses that I obsess about. This process will be fast, sudden and violent. Like the Spanish inquisition no one ever expects the mean-reversion. When the smartest value managers I know write investor letters where they talk about business quality and ignore valuation, who else is left to buy at these crazy levels. “growth” stocks have never been as crowded. Many people are openly joking about the alpha frauds create, as they throw in the towel on common sense and succumb to performance pressures. This is how tops are made.
In order to exploit this when it happens I have started putting on mean reversion trades keeping market neutral by shorting QLD (a proxy for 2x QQQ) i.e shorting growth, and buying IWN - the Russell Value index.
