One of the things our process is designed to identify is unsustainable extremes we can exploit, particularly when investor behavior prices either too much optimism or pessimism into equity valuations. Right now, the market continues to confidently price in a soft economic landing and the continued dominance of U.S. mega cap growth stocks. We believe this zealous optimism has overshadowed the growing risks posed by a dangerous combination of rising equity multiples and increasing interest rates.
Today we have anything but a uniformly priced market. It is bearish for U.S. indexes, while providing a great opportunity to look for mispriced stocks with strong fundamentals beyond the concentrated top of those indexes. The value of value relative to growth is back to historic highs, being driven by the extreme concentration of the top seven stocks in the S&P 500 Index (Exhibit 1). Never has so much liquidity been sucked into so few stocks, and the risk may prove a black hole for capital and weigh on returns due to increased volatility from higher correlations. continue...