Investing in growth businesses has paid off for most of this year; many online services have seen a boom in demand despite the weak economy. Should investors now look for value in the shares that have been left behind? The answer may depend as much on inflation prospects as it does on the course of the pandemic.
Betting on inflation has been wrong for decades. No-one quite knows why. Technology, global competition, excess savings and lack of business investment have all been offered as explanations for low growth and stable prices. Printing money after the financial crisis was expected to change this but the pattern has persisted. It means that growth is scarce and highly prized; future profits are valued expensively because interest rates are low. While all businesses have been forced to cut costs, some have used technology to steadily improve efficiency and have had a degree of pricing power.
The pain has been felt by companies with old style legacy business models; whether on the high street, banks, or heavy industry. And value investors, looking for cheap shares amongst these traditional businesses, have found it hard. Even the professionals have struggled; this year has seen a change in management of several value-based investment funds. Everyone thinks there is opportunity in the sectors that have been left behind - and indeed there have been some wins this year - but this year growth investing has been hard to beat.
The pandemic is by itself disinflationary, reducing demand and encouraging those who have maintained earnings to save more and rebuild their savings against future uncertainty. More unemployment may lie ahead until new businesses are established, and this also depresses consumer demand and economic activity. Some employers have found that flexible and remote working offers scope for efficiency improvement and hiring staff from further afield. The forces holding back prices seem to be still in place.
Might it be different this time? Certainly many western countries, including the US and UK, face levels of government debt unprecedented in living memory. Central banks have renewed determination to risk higher inflation. It always seems an easy way out of excess debt even though it may actually discourage the enterprise and economic renewal that is needed now.
Already, there are signs of physical constraints on some goods and assets. Anyone currently buying a car or moving house will have seen the strong demand and pricing in these sectors. Some areas of home improvement and wellbeing are also seeing widespread strong demand. Cycles, barbecues, pets and garden supplies have all seen demand run ahead of supply. And this overheating has extended into industrial areas where activity is harder to scale-up. This is happening at a time when many manufacturers are deciding to shorten supply chains to make their business more resilient, recognising there may be more challenge in moving essential parts around the world.
The boom in online businesses and the services supporting that may not end with better news on the pandemic. Many companies recognise they need to do much more to embed resilience in their online operations with relevant customer data and this will continue to drive cloud business services. But we may be heading for a more balanced economy with at least pockets of inflation. The rotation from value to growth has been extreme and there may now be opportunity in sectors left behind.
Legacy businesses will not stand still and not all will be disrupted out of existence. Management are responding and assets will be re-deployed. Already oil companies plan to transform themselves to provide more sustainable energy and some retailers are building new online delivery capability. Many supermarkets are busy developing parts of their car parks into blocks of flats and Edinburgh Airport plans a redevelopment of one of its runways. It might be time now for investors to think of a balance in their share portfolios.
A version of this article was published in The Herald on 07/10/2020.