Value investors have been anxiously waiting for a top, although a few short-sellers are waiting patiently for their positions to pay off. Legendary value investor Warren Buffett‘s Berkshire Hathaway actually bought shares of growth/ momentum play Amazon, and one value fund manager questions whether he may have finally capitulated to the seemingly endless momentum and growth cycle.
The long/ short RBI Capital Partners was down 4.6% gross and 5.2% net for the second quarter. The short-only RBI Capital Kodiak fund was down 5.4% gross and net for the quarter. The long/ short Partners fund was down 3.4% gross and 3.6% net for June, while the Kodiak fund was down 7.8% gross and net for the month. For the first six months of the year, the long/ short fund is down 6.4% gross and 7.3% net, while the short-only Kodiak fund is down 17% gross and net.
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In his second-quarter letter to investors, which was reviewed by ValueWalk, RBI Managing Member Skip Tague noted that growth stocks outperformed value names by 2%. Year to date, growth has outperformed value 8%. Over the 10 years ending in 2018, the Russell 1000 Growth index is up 15.3% annualized, while the Russell 1000 Value index is up 11.2%. Interestingly, last year when the broader market indices were down, growth outperformed value by 7%, although usually in such environments, value outperforms.
Tague notes that even though value has outperformed growth over the long term, some are suggesting this time could be "different or permanent." When he heard the news that Buffett's firm had revealed a stake in Amazon, which was trading at 72 times P/E and 23 times EBITDA, he could hardly believe it.
"I never thought I would read this news—the king of value investing buying THE growth stock of the last 20 years," Tague wrote. "Is this 'capitulation'? Is this a sign that the out-performance of growth over value has run its course?"
He also noted that momentum stocks have been "working in a big way," with momentum longs beating the market by about 6%. Although he has seen times of bigger outperformance, he pointed out that momentum shorts have been performing especially bad compared to the overall market. He added that in recent years, more and more money has been chasing "Growth At Any Price" stocks.
He has been surprised at the magnitude of multiple expansion on companies that beat earnings forecasts and had positive analyst estimate revisions. However, what has surprised him even more has been that this is starting to happen to companies that have only matched expectations without increased estimates from analysts. He expressed concern at how the market assumes everything will go right with "a positive corporate announcement relating to a long-term strategy with little quantitative details.
"This seems idealistic," he said. There is a notable lack of realism among investors in certain sectors and companies."
He added that 60% of RBI's assets are shorts in "companies with rising stock prices and very high valuation but flat or declining fundamentals." However, such positions have cost the partnership 12% over the last year, he explained.
While some called the fourth quarter the start of the bear market, Tague noted several signs that the bubble is still inflating, particularly in private equity, real estate and initial public offerings. Specifically, he pointed out that 80% of the IPOs are companies going public with losses in net income, and the last time this happened was in 1999 and 2000. Pinterest was up 80% from its IPO price in eight trading days. Zoom Video climbed 175% after its April IPO, while Beyond Meat gained 568% since its May IPO.
Tague also pointed to a strong correlation between the fund's results and Federal Reserve policy. The fund performs well when the Fed is hawkish but struggles when the Fed is dovish. Because of how sudden the market's reactions are, he believes the movements are driven by computerized quant models and possibly also by sector ETF flows. Because he read that 85% of the market trading volume came from participants who don't buy based on fundamentals, he believes it's impossible to compete in the short term. Thus, he has been trying to think more long-term when it comes to RBI's short positions.
The short-term game of trying to position in front of the next quarter's earnings release seemed crowded," he explained. "My traditional time horizon of 3-months to 9-months felt increasingly competitive and the alpha was shrinking."
Thus, for long-term short positions, one could look for companies whose business model is at risk with deteriorating fundamentals and secular challenges. However, the problem is that these companies usually already trade at low valuations and become activist and acquisition targets.
The other strategy for seeking long-term shorts is based on valuation, which he said includes "companies trading at high valuations relative to growth rates, and fast-growing companies trading at extreme valuations." These are the types of companies he prefers to focus on for his short positions.
"I also vividly recall the bear market of 2000-2002 when expensive growth stocks declined precipitously and in some cases have still not recovered, 17 years later," he explained. "My thought process has been to assume the high growth continues and margins expand, then assign a valuation in the future and discount it back to the present."
He believes that eventually such stocks will revert back to their fair prices. For now, "bulls who buy technical momentum (greater fool theory) or bulls who buy 'GAAP' stocks—Growth At Any Price" have been opposing his trades. However, that the upside risk is far less than the downside reward while waiting.
"Experts argue with me that there is no catalyst to start the decline," he wrote. "My retort is that if one waits for the obvious catalyst, one misses the high-price entry point, as the stock usually begins declining long before any negative news."
He sees two macro catalysts which could trigger the eventual decline, and they are interest rate hikes and a general bear market. Even though June was particularly difficult for RBI and a surprise to him, he remains optimistic about their short positions.
"If the bond market is correctly foreshadowing a recession, stocks will decline and likely begin the next bear market," he said. "That should be good for our valuation shorts."
The fund is short software-as-a-service and semiconductor stocks due to their valuations. These positions have hurt its results.
Tague highlighted Ultra Clean Holdings, SPDR Gold Shares ETF and Altra Industrial Motion Corp as winners for the fund on the long side. On a technical basis, he believes gold is in the early stages of a bull market, adding that it is the fund's only position that "acts well on days that interest rates decline." He mentioned Mylan, Urban Outfitters and Albermarle Corp. as losers on the long side.
On the short side, winners were Texas Roadhouse, Tesla and Astec Industries, while losers were Wingstop, Shopify and First Solar. The fund remains short Wingstop, which is its largest position, and Shopify, but it covered the First Solar short. RBI also covered its Texas Roadhouse and Astec shorts but remains short Tesla. Tesla remains a hot short position among many hedge funds.
This article first appeared on ValueWalk Premium