Fidelity International

Sifting through the wreckage, stock by stock

26 May 2022

Jeremy Podger, Radhika Surie e Girish Bhatia, Global Equity Portfolio Managers na Fidelity International, assinam o artigo abaixo no qual argumentam que esta é uma daquelas alturas para começar a procurar excelentes oportunidades, quer em stocks de valor, mas também em stocks de crescimento que têm sido arrastados pelos destroços do mercado:

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The value of investments and the income from them can go down as well as up and the client may get back lessthan they invest.
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Past performance is not a reliable indicator of future returns.

"Worries about the ongoing Russia Ukraine war, snarled supply chains, rising inflationary pressures andfears about possible recessionary slowdown have resulted in weakness across markets. In the belowperspective note, Portfolio Manager Jeremy Podger shares his observations on recent marketdevelopments in what has been a challenging environment for fund managers. He also shares his views onwhere opportunities are now beginning to emerge.

A dramatic market correction like the one we have just seen can be a humbling experience for fund managers. Tothe end of last week (20 May 2022) the NASDAQ index, a bellwether for growth investors, had fallen nearly 30%from its high in November last year and 20% in the short time since the end of March (1).

Smart observers put the blame on rising bond yields (and rising real yields in particular) which mathematicallydevalues earnings further out more than near term earnings. "Jam today" becomes more appealing relative to"jam tomorrow". So, valuation spreads within the market tend to get compressed - which is what we have seen.

But there can be little doubt that the massive monetary stimulus thrown at markets caused distortions and anelement of euphoria that we haven't seen since the heady days of the tech bubble in 2000. Not only did we seeenthusiastic participation by retail investors in the US, but we also saw brokers falling over themselves to justifystratospheric prices with creative valuation techniques.

It is worth revisiting what happened some twenty years ago. NASDAQ peaked in March 2000 and did not reachits subsequent absolute and relative lows until the fourth quarter of 2002 (albeit after the shock of 9/11 and acouple of negative quarterly GDP numbers). The whole cycle lasted for around five years. From start 1998 to end2002, the NASDAQ actually managed to underperform the S&P 500 Index, unwinding the 150% outperformanceseen up to March 2000. That is not to say all tech stocks fared that badly1. But of course the bubble conditionshad brought a huge raft of early-stage companies to the market, expanding the growth universe at stupidly highvaluations, and their falls were generally spectacular, making the correction even worse.

We are seeing a similar thing now. The Renaissance IPO Index, which measures the performance of new issuesover the past two years, has shockingly halved this year (2) (down c. 48%). It makes one wonder what on earthinvestors were thinking when they participated in these IPOs.

Maybe it was partly the desire to emulate the success seen by many venture capitalists in recent years by gettingin on businesses in their early stages, hoping that they would come to dominate their niches. The trouble was thatmany issues were priced as if they had already achieved that dominance. Just as in 2000, the market chose toignore the threats of competition and obsolescence. (Recall the sad demises of AOL, Nokia and many others). Butthat thinking has now been invalidated. A bear market breaks the bones of a trend, and we are not going to getback on that track for a while.

Did we avoid the temptation to participate in new issues? The Fidelity Global desk did intensive work on morethan 35 flotations in the past two years. Of those we seriously looked at, we passed on over 20. These fell by anincredible 60% from issue price to the second week of May. The IPOs we thought looked interesting weremassively oversubscribed and where we decided to participate, we received tiny allocations and the immediaterises in price meant there was no sense in holding on to most of them. On those issues that we sold; we saw anextraordinary gain of over 50%. Those shares are now down by an average of over 50% from our exit price. Wecontinue to hold three IPO positions and on average these are almost at breakeven. Not a bad tally, but becausethe amount of investor capital we deployed in this exercise was relatively small, the contribution to our globalequity strategies was modest.

We now look forward to a somewhat quieter period for new issues and more sensible valuations. We are startingto have a glimpse of a number of possible flotations that are likely to come later this year and there are some thatpromise both good growth potential and strong current profitability. A return to normality here will be very welcome.

Whilst valuations of growth stocks in general and technology in particular have not yet corrected to their longertermaverages, it looks like it is time to start looking for new opportunities amongst the long list of casualties. Formost of the past two years, we have avoided most high growth stocks because we thought their valuations wouldprobably fall over the next few years. That risk may not have gone away, but it is now less of a threat than it used to be.

We have made a start by going back on our previous work and have just recently cautiously begun to accumulateone of those new issues which had fallen from grace. And we are working our way through the wreckage inindustries that people used to love and now don't. This is going to be a challenging task. As prices fall, we discovernew reasons why once-favoured growth companies are perhaps not quite as attractive as we might have thought they were.

For example, looking at one field of medical technology, last week we sat down with one of our analysts to discuss genomics companies. Genomics is a fascinating area which underpins cancer detection and therapies and diagnosis of genetic disorders. This was an area that we had found intriguing last year but had been unable to square with valuations. Of the ten companies we looked at, seven were down over 60% in the year to date. This is a fast-changing industry and the competitive landscape is constantly evolving. Larger companies are involved in patent disputes and smaller companies are trying to leapfrog incumbents with better, cheaper solutions. Risks in individual names remain high and it is by no means clear we are faced with real bargains in this area.

In March we commented on some longer-term market issues. Two are worth reiterating. Firstly, Technology is not the only answer. Many technology companies saw a huge acceleration of growth during the pandemic, and we need to adjust to a deceleration and in some cases a reversal now. There will certainly be many new opportunities in tech over the coming years but equally important will be how non-tech companies internalise technology and use it to their competitive advantage.

Secondly, Growth is not the only way. As we have seen in the past six months, the penalty for disappointment by high rated growth stocks can be far larger than for cheaper value stocks. Even with the recent correction, growth stocks are still more expensive (against expected near term earnings) than they were five years ago and value stocks are cheaper than they were. Growth fund managers have felt the pain this year, but it is doubtful that any have really yet shifted their investment process. So while we are now getting into gear to find good growth stocks caught up in the market rout, there are still many value stocks that look attractive. It is one of those times when it appears to be best to start to look for outstanding opportunities in both growth and value camps rather than trying to hide in the middle ground.

Sources and Footnotes:

(1) Source: Fidelity International, Bloomberg, 20 May 2022. Returns for NASDAQ Composite Index in USD.

(2) Source: Fidelity International, Bloomberg, 20 May 2022. Returns for The Renaissance IPO Index in USD. It is a diversified portfolio of US-listed newly public companies that provides exposure to securities under-represented in broad benchmark indices. IPOs that pass a formulated screening process are weighted by float, capped at 10% and removed after two years.

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Fidelity International offers investment solutions and services and retirement expertise to more than 2.5 million customers globally. As a privately held, purpose-driven company with a 50-year heritage, we think generationally and invest for the long term. Operating in more than 25 countries and with $706.3 billion in total assets, our clients range from central banks, sovereign wealth funds, large corporates, financial institutions, insurers and wealth managers, to private individuals.

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