Global Markets – 3Q20 Review

International stocks rose in the third quarter, with the MSCI EAFE Index posting a return of 4.8%.  The gains in the quarter were front-end loaded in July and August, as stocks pulled back in September on heightened concerns about the rise in COVID-19 cases taking place across Europe.  International stocks trailed the U.S. markets (defined as the S&P 500 Index), which continue to be paced by a narrow handful of large tech companies.  Although the S&P 500 Index has outperformed the EAFE Index by a wide margin on a year-to-date basis (5.6% vs. -7.1%), the spread narrows considerably when looking at the S&P 500 Index on an equal-weighted basis (-4.8% vs. -7.1%).  This speaks to the outsized contribution of the ‘FAANG’ companies in 2020.

Outside the U.S., Japan and core Europe were positive contributors to the benchmark return, while UK stocks lagged in the quarter.  In the aggregate, UK stocks have endured a more difficult 2020 relative to the broader international markets.  Britain incurred the highest death rate from COVID-19 amongst its European peers, and the recent increase in social and work-from-home restrictions is further hampering the recovery.  Uncertainty as to the government’s preparedness for the year-end expiration of the transitional trade agreement (remember Brexit?) has been another headwind for UK stocks.  The prospect of the UK leaving the European Union at the end of the year without a trade deal (and the commensurate hit to the economy) has investors moving to the sidelines until there is more clarity on this front.  Cambiar’s view is that a hard Brexit is a lower probability event – an agreement will likely be struck in the late October/early November timeframe, which allows sufficient time for ratification in the UK and European parliaments.

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 MSCI EAFE Growth Index gained 8.4% in 3Q, vs. a return of 1.2% for the MSCI EAFE Value Index.  The quarter brings the year-to-date spread between the two benchmarks to almost 2300 bps – the widest divergence on record.  While recognizing that our clients have likely reached a level of fatigue with the value vs. growth narrative that has dominated this cycle, we 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 cashflow 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.