Large Cap Value – 2020 Review & 2021 Outlook
Cambiar President Brian Barish evaluates 2020 performance for the Large Cap Value portfolio and details what could be ahead for 2021.
Good day. This is Brian Barish, president and CIO of Cambiar Investors. I’m here to review performance in our Cambiar Large Cap Value strategy for last year with an emphasis on the second half and our outlook for 2021. For the year 2020, our large-cap strategy gained 18.7%, gross of fees, which outpaced the Russell 1000 Value Index by 15.8% points, and it was slightly ahead of the S&P 500. Most of the gain happened in the fourth quarter where we were up 16% which was about in line with what the Value Index did. However, through a lot of good decision-making over the course of the year, we were very far ahead at the beginning of the fourth quarter.
2020 is one of the best years we’ve had in relative performance terms and I’m extremely pleased. It was a total team effort by our domestic research group, there were not a lot of weak spots. We did have the greatest gains in the technology sector led by semiconductor names such as Marvell and Applied Materials. We also did really well in industrials led by Train and HVAC company, PPG and Industrial Paint Company and United Parcel Service, which drives bam trucks and delivers parcels. Most of the losses were in financial stocks, such as AIG, Citibank and Wells Fargo, all of which we moved off from over the course of the year and in travel linked companies such as Delta Air Lines and Raytheon. Beyond those, there just weren’t a lot of losses.
Obviously, the volatility was incredible, and this led to a couple of big rotations of stocks in the portfolio. The split between growth and value stocks was astonishing in 2020, large-cap growth gained 38% for the year or 35% points better than value. Truly unbelievable and one of the largest spreads on record because of the way that value indexes are constructed, the stocks that comprise value indexes tend to be asset heavy and derive less of their business from intellectual property.
This means they were vastly more exposed to the economic drawdown because they’re more exposed to the physical economy. We have a lot more to say on this topic in our white paper and collection of short podcasts called the virus plaguing value, which is available on the Cambiar website. Entering the year, it seemed reasonable to believe the global trade would get somewhat better after a two year period of decreases, mainly a result of tariffs in policy uncertainty. Offsetting this positive view, the US yield curve had briefly inverted in 2019 and was very flat in early 2020 suggesting some caution in banks and other interest sensitive stocks. That caution definitely helped us because we did not have a lot of financial exposure when the pandemic hit.
Obviously, all forecasts went out the window when the need to lock down and distance became evident in the first days of March triggering an instant bear market of 34% for the S&P 500 Index. Stock market declines around the world where generally in line with this range, the freakish and unusual nature of the pandemic and the recession brought outsize policy responses from the world central banks and governments. Clearly, individual businesses are not at fault in a wall of liquidity to support credit and the flow of money was instituted by the fed, which added three and a half trillion dollars to their balance sheet in the space of about 10 weeks leading to massive expansions in all kinds of monetary aggregates. These conditions still prevail today, banks are washing cash, consumer savings is at nearly all-time high levels as is the stock market.
The stock market went through a number of violent internal rotations through the year, and that’s putting it mildly. During the spring and summer, pandemic beneficiaries tended to do best along with digital economy stocks whose growth was in some way enhanced by the lockdown. We happen to own a few pandemic beneficiaries in the large-cap portfolio, during the summer months, we trimmed a lot of our positions and sold the other pandemic beneficiaries outright.
We reasoned that investors were eyeballing one-time gains in their financial performance that won’t repeat in the future and felt it best to reallocate capital back into stocks more obviously disconnected from their financial prospects in the normal economy. Initially, that meant rotating some of this capital into industrial stocks. So just train PPG and Union Pacific, but these stocks also catapult the tour price targets quickly as investors began to eyeball and outsize economic recovery when the pandemic ends during the third quarter. This led to piling into the industrial stock category.
We have been following the vaccine trials closely, and we were reasonably convinced in the late summer and run up to the election that one or two of the vaccines being developed would show clinical success. This led us to move capital into a new group of return to normal stocks. These are businesses where some form of people being able to congregate again, is a critical part of the story. This led to investments in Southwest Airlines, Sysco the food services supplier not the networking Cisco, retail T.J Maxx and Uber. Uber is not a traditional value stock, but does represent a digital platform business that benefits greatly from the liquidity-driven marketplace effect that tends to be a hallmark of the most successful digital platform companies.
There’s also a clear beneficiary of a return to normal, along with a much more profit-minded management team that replaced the founders in 2019. We rounded out our purchases with several healthcare and defense sector stocks, this included Bristol Myers and insight pharmaceuticals and healthcare, along with adding to our position in Centene, a medical care organization.
In the fourth quarter, positive vaccine news did arrive, which put strong investor interest into returned to normal stocks. We added just enough to keep up with the rally in the fourth quarter. If you’re looking for stocks that are inexpensive in an otherwise clearly expensive stock market, healthcare, defense and possibly financials are your potential shopping basket. There are reasons for this, however, both defense stocks and healthcare stocks, long-term earnings outlook depends a great deal on government policy decisions and rules. In other words, they don’t fully control their own fate.
We are reasonably confident that the regime change in Washington will be manageable, but knowing this for sure will take some time to prove out. The other glaringly cheap stock sector is financials, and the outlook for these depends immensely on interest rates, inflation in the policy actions of central banks. And that is certainly a very complicated topic. Entering the fourth quarter bank valuations were cheap enough that any glimpse of improvement was apt to be rewarded and it was. Longer-term negative population growth, the dephysicalization of key parts of the economy as we move into the digital age, and high sovereign debt loads don’t make a strong case for systematically higher interest rates. But in 2021, there’s a pretty good chance that rates rise off of low levels helping the financial stock sector and its earnings outlook.
So what’s our forecast? Well after a year like 2020, the very thought of making broad forecasts as though we really could know the future seems like an indulgent moral hazard. The current forces at play: a pandemic and lockdowns, vaccines, huge pent-up consumer and industrial demand, immense consumer liquidity, stimulus beyond anything we’ve seen in our lifetimes, and the pervasive adoption of numerous disruptive technologies. There’s a lot coming together and we just don’t know how this confluence could be predictable. We’ve had some views about the coming year a year ago, and they did not include a pandemic. That forecast was shot 60 days into the year.
Deep in the pandemic, I’d surmised that given the severity of the bear market, a full economic and stock market recovery might take years. Wrong again. Fortunately, we kept buying stocks as they came to us, otherwise we would not have had such a good year. So, any forecasting now about markets and world events comes with a very heavy dose of humility. We will keep buying stocks in 2021 as they come to us and selling them if they become too hard to rationalize.
That said, we do see a few things as being more likely than not. First, we do see a synchronized global economic boom once various vaccines are broadly distributed, which we estimate will be in the second quarter for most adults. This could mean GDP figures of seven to eight percent in the US for all 2021, which are the highest numbers on record since the early 1950s. Other developed countries will see similarly outsized growth numbers off of low-based comparisons, and these will happen largely all at the same time. This means an intense burst of demand for pent up consumption, production, vacations, medical procedures, supply chain, inventory restocking. You name it, it’s being under-produced and under-consumed relative to sustainable demand.
Second, on the public policy side, you do have max stim. Governments and central banks are pushing money to businesses and individuals, easy money through the financial system, and all largely at the exact same time. It’s a powerful combination of policy, consumer liquidity, and a gating factor on putting all of that to use that none of us has really ever seen before.
Third, we do continue to think that money supply growth and changes in the rate of growth are very important to watch. High money supply growth is a critical factor in the stock market’s valuation expansion, and this will slow down later in 2021, and down a good deal more in 2022 as the economy reopens and the fed tapers down on its open-ended bond buying program.
Fourth, given the valuation expansion that we’ve seen in the last 12 months and the prolific speculation in stock markets, we imagine that the talk of bubbles becomes rather loud in 2021 as the year marches onwards. This begs the question, what is a financial bubble exactly? Well, there are a few popular definitions. One is a situation in which asset prices rise and appear to be based on implausible or inconsistent views about the future. Number two, a protracted period of low risk premiums. Number three, a period of time in which asset prices reach levels that are strongly in excess of intrinsic value and rise rapidly to these levels. More cynically, herd behavior that asset managers get fired for not owning. And fifth, all of the above, but still economists claim they cannot see them. Sarcasm aside, let’s just say that items number one and number two look very plausible right now. Are there any telltale precursors of bubbles that we can spot with the naked eye?
The fuel for asset bubbles is much less controversial. There are usually three key ingredients. First, easy money and excess liquidity. Check. Second, the suspension of disbelief by market participants. I would say also a check. Third, some kind of paradigm shift or new technology that precipitates this. Well, there are definitely some paradigm shifts abounding in individual sectors. It would take a long, long time to go through them all. Maybe there’s a larger paradigm shift fantasy that inhabits investor minds today on the very concept of easy money itself. Investors expect the world’s central banks to keep trying and keep failing to generate durable inflation, justifying paying exorbitant prices for intriguing growth stories.
The situation is reminiscent of the turn of the millennium, when stock valuations were not cheap, but not terribly demanding either for older and stodgier companies. A smaller group of market darlings possessed hyper normal valuations and implausible business cases. We see something awfully similar in 2021. And as moral hazard gradually creeps back into our vocabulary, there may be some reckoning to be had.
The reopening that we are all usually waiting for may very well be the reckoning. Given the challenges of turning on so many supply and demand chains to full steam all at once, we envision shortages of many products and some potential for aggressive pricing to clear markets. It seems likely, and maybe highly likely, that the world may see a bout of cyclical inflation in 2021. Markets would not be very surprised, and at some level it would be welcome. Sticking the landing.
Do they have a plan? That’s one way of looking at it. And we may be at least one year too early on this, but it’s at least worth pondering. What if we get inflation and rates rise and the asset bubble pops? Asset bubble pops tend to be deflationary. Or alternatively, what if we don’t get much inflation after all in the next stim, after the next monetary accommodation, after all the truly unprecedented pent up supply and demand issues? It would be as though developed countries are turning into Japan, liquidity trap and all. Either way, the case is strong for maintaining balance in stock portfolios and some care as to valuation and the underlying assumptions behind each stock. In other words, be careful. Don’t assume moral hazard is gone forever.
Thank you for tuning into the Cambiar Large Cap Value podcast. We appreciate your continued support.
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Certain information contained in this communication constitutes “forward-looking statements”, which are based on Cambiar’s beliefs, as well as certain assumptions concerning future events, using information currently available to Cambiar. Due to market risk and uncertainties, actual events, results, or performance may differ materially from that reflected or contemplated in such forward-looking statements. All information provided is not intended to be, and should not be construed as, investment, legal or tax advice. Nothing contained herein should be construed as a recommendation or endorsement to buy or sell any security, investment or portfolio allocation. Securities highlighted or discussed have been selected to illustrate Cambiar’s investment approach and/or market outlook. The portfolios are actively managed and securities discussed may or may not be held in client portfolios at any given time, do not represent all of the securities purchased, sold, or recommended by Cambiar, and the reader should not assume that investments in the securities identified and discussed were or will be profitable. As with any investments, there are risks to be considered. All material is provided for informational purposes only and there is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation.
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