Mark Fowler: Who wins the value versus growth debate?

Surely growth will ultimately win the value versus growth debate? Photo / Greg Bowker

Opinion

COMMENT:

Over the past three decades, central banks and technology have in most markets reduced risk-free interest rates towards zero (and sometimes even negative), and central banks' intolerance of financial market volatility (equity markets going lower in price) has largely contributed to a sustained drop in the cost of equity.

In most jurisdictions, the cost of equity is now in mid-single digits (e.g. in Asia ex Japan it is ~5.0-5.5 per cent, while in the US it is closer to 4.0 per cent to 4.5 per cent). At that point, most projects become viable, and as corporates scramble for deals that yield any meaningful return, the pool of viable opportunities diminishes, forcing an even more aggressive competition, driving both cost of equity and returns ever closer towards zero. It is a vicious cycle.

The Information Age appears to have an almost infinite scalability. Labour is no longer the key productivity driver it once was. Monetary and fiscal policy has created a global surplus of capital; hence, as the cost of capital continues to fall, conventional capital allocation becomes meaningless and "zombie" businesses can survive but are unlikely to prosper.

So why is it important to investors? In my view, these differences explain why certain sectors and stocks appear to defy gravity. In a world of excess capital and suppressed business and capital market cycles because of government intervention, any corporate that appears to have significant growth opportunities is rewarded with an almost infinite valuation, amplified by a near zero cost of money. Tesla, for the moment, is the most obvious example of this.

However, the same corporates (value stocks) that suddenly lose this capacity get quickly devalued. Corporates that rely on more traditional tangible assets that are profitable and boast good balance sheets and dividends become steadily cheaper, held back by their limited growth potential. These are not to say that they are not good businesses, merely the market questioning "where is the growth?"

If we are to draw these conclusions, then surely growth will ultimately win the value versus growth debate? Unlike talk of asset bubbles, are these relative valuation gaps part of a longer-term unavoidable change? Growth and thematics are likely to become more expensive over time as conventional businesses with limited growth opportunities de-rate. This doesn't mean we can't and won't enter periods when the gap between value and growth is too excessive; however, it appears that those who don't adapt get left behind.

• Mark Fowler is head of investments at Hobson Wealth Partners.