Could It Really Be Different This Time?

Just like serious golfers cringe at the words, “You are still away.”, investment portfolio managers are careful not to utter the words, “Things are different this time!” Although it is unlikely that Tiger Woods or Phil Mickelson would be told that they are still away following a putt, could it be that the phrase, “Things are different this time!” in the investment field may be ringing true. We say, not only perhaps, but probably so.

Yes, it could be that the “Great Rotation,” as it has been called and falsely predicted for the last decade, could finally be coming to fruition. This rotation references moving the focus away from Growth Stocks toward that of Value Stocks. And, because we don’t really like the conventional definition of Growth vs. Value (after all, what investor doesn’t want companies whose earnings are growing and increasing in value?), we would suggest that the Great Rotation would be turning its focus away from speculative companies and toward companies possessing characteristics of quality.

Speculative companies are typically disruptive in nature, focusing on new technologies that have taken years to develop with steep upfront costs. They have, in essence, developed, if you will, the new or better mousetrap. Moreover, speculative companies tend to thrive in an environment where interest rates are low, and inflation is benign or nonexistent. Reason being that speculative companies typically finance the early stages of their growth cycle, thus resulting in lower expenses and higher margins. Moreover, if inflation is low, it is usually accompanied with lower economic growth. When growth is hard to find, investors will pay a premium or pay-up for it. However, when the opposite occurs, interest rates rise accompanied with higher inflation. This in turn is associated with higher borrowing costs and typically stronger growth, which harm speculative companies.

Quality companies have the opposite characteristics. They are established, borrow very little or no money, have stable cashflow, and wide moats negating the competition from penetrating their marketplace. Although they possess mighty earnings in numbers, they are further along in their lifecycle and the earnings rate of growth is not as fast as it once was. When rates rise, it does not affect these businesses because they didn’t borrow or borrowed very little. In addition, because the economy is usually growing in periods of inflation, the rising tide lifts all boats, and one is no longer forced to pay a premium to own speculative growth stocks because investors can get it now from mature companies as well.

We believe that the time may just be right for the Great Rotation to unfold as the Powell-led Federal Open Market Committee seems convicted to the core to raise interest rates and has removed the word “Transitory” as it pertains to inflation from their lexicon and replaced it with “Persistent” as they believe it to be real this time. This could just allow for the ideal backdrop that permits the words “Things are different this time!” to finally ring true.

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