Domestic Markets – 3Q20 Review

U.S. equities continued their ascent in the third quarter, with the S&P 500 Index posting a 9% gain.  Small-cap stocks (defined as the Russell 2000 Index) climbed 5%, illustrating the broad-based nature of the rally.  The gains in the quarter would have been greater were it not for a pullback in September on concerns that a rise in COVID-19 cases (largely associated with back-to-school openings) could hinder the pace of the economic recovery.

Each of Cambiar’s domestic strategies performed well in the quarter relative to their primary benchmarks, widening their year-to-date (and longer timeframe) excess return differentials.  Given the portfolios’ emphasis on quality and downside protection, we were encouraged that the bulk of the 3Q alpha was sustained in the September drawdown.  Cambiar remains focused on consistent execution in the underwriting of new positions, maintenance of existing holdings, and selective avoidance of industries/companies that do not meet our investment criteria.

Growth vs. Value – Still Going…

Once again, growth stocks outpaced their value counterparts in the quarter – prompting the Energizer Bunny reference from the early 1990s.  The Russell 1000 Growth Index gained 13.2% in 3Q and has now returned 24.3% in 2020.  In contrast, the Russell 1000 Value Index gained 5.6% in the quarter and has a year-to-date return of -11.6%.  The YTD spread of 3600 basis points is the widest divergence on record – including the dotcom bubble in the late 90s.  The market’s preference for all things growth may not yet be at euphoric levels, but when stocks rally by 50% (e.g., Tesla, Apple) after announcing a stock split – we have to be getting close.  At a minimum, clients who embrace the concept of buy low/sell high should consider a rebalance to their value allocations, given the high multiples now assigned to many growth companies.

Recognizing that our clients have likely reached a level of fatigue with the value vs. growth narrative that has dominated this cycle, Cambiar would argue that this dynamic grows in relevance each day these spreads continue to widen.  There is no question that the pandemic accelerated a number of trends that favor growth stocks.  But there are logical limits to prices, no matter how strong the underlying fundamentals.  Financial gravity is a very real investment concept, despite the growth at any price behavior that has currently overtaken the market.

The sentiment around value stocks could not be much worse than it is today.  Despite the extended out-of-favor status currently ascribed to value, Cambiar continues to believe that buying companies using a price-sensitive approach remains a key variable to compounding capital over time.  If outperformance is a function of exceeding expectations, shouldn’t one be inclined to look in areas where expectations are low?  The key here is to avoid the false positives that often accompany a process that is overly enamored by low valuations.  A traditional low Price/Book philosophy was successful in the industrial age but has been less effective as the world transitions to a digital economy. Cambiar’s relative value discipline seeks companies that are trading at reasonable valuations – but we attempt to avoid value traps by prioritizing quality over statistically cheap stocks.  Quality can take on various meanings; Cambiar attempts to remove subjectivity by evaluating metrics such as leverage, free cash flow, and return-on-equity/return-on asset metrics.  We then determine an appropriate price level to attach to these attributes, with the goal of providing both a margin of safety as well as an attractive upside return over a forward 1-2 year timeframe.