Why this value investor believes the opportunity set is growing

If we were going to characterise 2023 in investing terms, you might say it’s been a year for growth investors – especially when it comes to tech. When you get into the detail though, the picture is less appealing. Many experts have spoken on Livewire about the concentration risks from the magnificent seven – but the performance of these big tech firms is also obscuring the state of affairs in the broader market.

As Cory Martin, CEO, executive director and equities portfolio manager for Barrow Hanley, notes, equities outside of the magnificent seven have underperformed and the narrowly-driven market is creating massive dislocations.

“This distortion in the market is creating a lot of opportunity in terms of valuations for the rest of the market,” Martin says.

He argues we’re seeing the start of the value cycle and is tilted on the side of defensive positioning for the coming year.

In this episode of Views from the Top, Martin discusses where we are in the market cycle, how he is taking advantage of dislocations, and what he is most excited and most concerned about today. He also shares how value investors can still invest in the big growth trends like AI.

Topics covered:

• 0:25 - Why value in the growth v value debate 
• 1:37 - Where we are in the market cycle 
• 2:44 - Market outlook 
• 4:35 - Taking advantage of market dislocations 
• 6:02 - Positioning 
• 6:40 - Value opportunities in financials 
• 8:03 - Opportunities in the insurance space 
• 8:40 - How to approach AI from a value perspective 
• 11:31 - Most exciting and most concerning trends 
• 14:44 - The timing for a recession 
• 16:05 - Cory Martin's view from the top

Why we are at the start of the next value cycle

Please note that the commentary below is an extract of the key insights in the interview. For all of the insights, please watch the video. 

After a year fuelled by extraordinary AI-driven growth in tech stocks, it may come as a surprise to suggest that we’re coming into a value cycle, but Martin points out this follows historical trends.

“It's not uncommon to have a strong growth rally within a secular value cycle. If you think back coming out of the tech bubble, there was a very strong value rally that it lasted until 2008 in the GFC. But during that time, we had very strong short growth rallies like we've just witnessed with the magnificent seven. The opposite is true in growth-led markets,” he said.

Martin is seeing tremendous opportunity across the markets and you can partly blame the magnificent seven for this.

“One of the things creating opportunity, not just for value managers but for all active managers, even quality growth managers, is that when you get a market that is so narrowly driven and the majority of the broad market returns is from a handful of stocks, it provides massive dislocations and valuations for the rest of the market,” he says.

One area he points to is the financials space.

“The financial sector is 13.1% of the S&P 500 yet contributes 21% of the earnings. The market cap relative to the earnings contribution is far superior to the magnificent seven relative to their earnings contribution,” he says.

Financials is the largest weighting in Barrow Hanley’s strategy, with nearly half the allocation in banks. Half of these are US-based, with the remainder in Hong Kong or emerging markets like Brazil or Thailand, where Martin is seeing high-quality, well-managed banks at cheap valuations.

Insurance also features heavily in the financials allocation.

“It’s become a hard market and the pricing power has gotten better. The types of companies we own are primarily property and casualty, and we stayed away from the reinsurers and other areas,” he says.

On the whole, the market dislocations have meant the opportunity to shift around the portfolio.

“We’ve been taking the opportunity to rotate and take profits in the cyclical areas of the market and redeploy in the more defensive areas like staples and healthcare. We’ve added some utilities exposure and a significant exposure to the materials sector, which had underperformed dramatically,” Martin says.

Why value investors can still take part in the AI trend

On the surface, it may seem like big tech trends, such as AI, are outside the remit of value investors. Not so, according to Martin, but you need to think differently to find the right opportunities.

“If we can exploit a theme related to it in other areas of the market, we will do that,” he says.

“We own an industrial company that, on the surface looks like it would have no relationship to AI at all. They’re the biggest provider of liquid cooling systems for data centres – the biggest in the US.”

He also shares an example of an industrial company that is the a leader in radar and sensors, one of the biggest providers of high-voltage connectors and wiring. It is very connected to the growth in autonomous driving.

It comes down to avoiding the high multiple front-of-mind plays when it comes to participating in big-ticket trends.

“We have to be very careful and smart about where we’re going and find opportunities involved in areas of these businesses that we’re almost getting the trend for free. That’s a classic value play,” Martin says.

What Martin is most excited and concerned about in markets today

The concentration risk mentioned earlier in The Magnificent Seven is key to what Martin is most excited about – the opportunity set he believes is getting bigger.

“There’s a huge opportunity set of cheaply priced companies to buy. In fact, a lot of the names we’re looking at are back to pandemic level lows,” he says.

On the flip side, he’s concerned that the market has priced in an end to US rate hikes and a soft landing – something he points out that the Fed has never been able to achieve.

“There’s usually a 12-18 month lag after the last raise in interest rates. We’re not there yet and so the cost of capital filtering through corporate America is not reflected yet,” Martin says.

He is seeing it start to hit small caps, particularly on the energy side, where the cost of capital is over 12%.

The key to handling this concern comes back to a bottom-up style.

“The thing I’ve learned over the years is there’s just as much risk in a stock on the downside if you’re wrong, maybe even more so than if you’re right,” says Martin.

He advocates spending an equal amount of time considering what a worst-case scenario can mean for a stock alongside what a best-case scenario could generate.

Whether or not we’re facing a recession, investors could do worse than think through the outcomes of their investments as Martin proposes – it’s about having conviction in what you hold after all.

Achieve long-term growth by investing in quality businesses

Barrow Hanley adopts a value-oriented, bottom-up investment process focused on in-depth fundamental research to identify companies that trade below their intrinsic value for reasons that they can identify, believe are temporary and have a clearly identified path to achieving fair value.

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