It’s nasty out there – and I’m not just talking about price action. On social media, self-described growth and value investors have been increasingly at each other’s throats since the turn of the new year. The other day on Twitter a snarky comment about Netflix’s valuation was met with accusations of…Nazi sympathy and being anti-science. Okay. I’ve been thinking a lot about the regime shift we seem to be witnessing and why the vitriol has been so intense of late.
Stepping back, the last 13+ months have been some of the most fascinating and emotionally volatile (market-wise) I’ve experienced. I’m sure plenty of plot twists lie ahead, but sitting here today it’s awfully hard not to feel like we just witnessed and are now coming out the other side of a compressed version of the 90s tech bubble. I won’t bore you with the long list of parallels, but that’s the backdrop.
While 2021 began with unprecedented pain and existential threats to short-sellers from the meme stock movement, it wasn’t just meme stocks and it certainly wasn’t just retail inflating the “speculative growth”[1] bubble. The last three weeks have seen the script flipped on its head. To make money now, own cheap stocks and short expensive ones. There’s not much nuance. The functional definitions of “cheap” and “expensive” are as simplistic as ever: big multiple (especially on sales) bad, low multiple (especially on free cash flow) good.
Looking ahead, there are two obvious paths. The first sees markets (speculative growth shares in particular) return to all-time highs and quickly. I’m thinking a few months – not a year or something that rounds up to a year. The second…does not. Down that path we’d see a continued grinding down and collapse of speculative growth stocks (serious bear market rallies mixed in, of course). But ultimately, speculative growth stocks don’t come all that close to prior all-time highs for years to come.
What I find interesting isn’t what the paths are (they’re obvious), but how explosive the outcome is likely to be. Each path involves a form of intellectual torture of a major group of market participants. Resolving that torture is what will accelerate the outcome.
If we quickly revert back to all-time highs (again, focused on speculative growth stocks), value investors that have been tormented consistently with underperformance since the end of the financial crisis (a casual 13 years ago) will be despondent. For about a month, this group has finally begun to get comfortable that their time has truly, finally come. They were right and the sacrifices were all worth it. You cannot take that away from them. But if you do! – expect the reaction in markets to be dramatic. It's not hard to see all but the most hardcore value investors throw in the towel en masse if we quickly see markets rotate hard back to speculative growth. This could accelerate us well past prior highs.
On the other hand, if we take the second path and speculative growth continues to grind lower, growth investors will be faced with a painful choice: continue holding, buying dips, and losing ever more money, or give up and sell to preserve capital. The former is increasingly scary, given the magnitude of the moves we’ve already seen (i.e. plenty of stocks already cut in half). The latter is incredibly difficult for emotional and intellectual reasons. Selling stocks whose fundamentals seemingly continue to be strong is a tacit acknowledgement that the valuation was just too damn high. Liquidating will bring up serious thoughts of self-doubt about the durability of the speculative growth style that had been so unbelievably successful. How would LPs react to former star growth managers acknowledging this?
Given the mental torture involved in making that decision and the fact so many growth investors have built identities entirely around growth above-all-else and decade-plus time horizons and valuation-as-a-tool-of-Boomers, I think most speculative growth investors are still holding out. It’s anecdotal (and prime broker data is varied[2]), but I mostly see speculative growth types sitting tight (or claiming to), carefully buying dips, ogling watchlists, trying to right past wrongs/errors of omission, and pounding the table on fundamentals.
From the perspective of a value investor (mostly), speculative growth stocks still look awfully expensive. Shopify, for example, has been cut in half and still somehow trades for almost 20x sales (130x EBITDA)! You can argue about fundamentals and that it’s the greatest business the world has ever seen – but that’s not what matters today and possibly for the foreseeable future.
I don’t know which path the market will take (bias is lower, but I just don’t know). But I think the nastiness we’ve seen of late is directly related to the painful, internal debate for growth investors (combined with value investors finally allowing themselves to smile and poke their growth counterparts). We’ll know in the months ahead that one side was very, very wrong. And it is that painful acknowledgement that should accelerate the move in whatever direction the market takes.
That's all for now.
-- George --
[1] My definition of “speculative growth” is mostly “know it when you see it.” If a stock trades for 20x sales, it is speculative growth (not judging!). If a stock has virtually no sales and a multi-billion dollar valuation based on fluff, it is speculative growth (I am kind of judging).
[2] Exposure to growth has clearly pulled back, but the extent depends on how long a time horizon one is considering (and changes to index composition over the past two decades).