We may still be in the grip of the pandemic – especially here in Europe – but markets are forward-looking and investors are already positioning themselves for a bright post-pandemic future. As such, in the investment world, Value stocks seem to be back in vogue.
Value investing typically means looking past glitzy, high-flying names to consider “unloved” companies with less pizzazz. Finding Value stocks is akin to “bargain hunting”; they tend to trade at a discount to fundamental metrics such as book value, earnings, sales or dividends and so on… While it is possible to find Value stocks in each sector, a good place to look would be in areas such as Financials, Materials, Airlines and Retail. Investors typically buy Value stocks when the economy is in an expansionary phase, when corporate profits are climbing upwards, when the expectations for long-term interest rates are rising and when a “risk-on” mode permeates through markets. In contrast to Value stocks, Growth stocks are equities of companies with strong anticipated growth potential; a textbook example would be the FAANGs or constituents of the NASDAQ index.
In contrast to Value stocks, Growth stocks are equities of companies with strong anticipated growth potential.
Value versus Growth
Historically, Value styles have slightly outperformed growth, but the outperformance comes in long cycles which are correlated to the fixed income market. In the past thirty years, against a prolonged bull market in bonds, Value has lagged behind Growth – but not without bouts of overperformance.
The period after US President Trump was elected in November 2016 is a good example of such a time. Trump’s stimulus plan, which included a $1 trillion infrastructure spending package, de-regulation and tax cuts, ignited a wildfire of economic optimism. Expectations for inflation and long-term interest rates rose and from November until the end of 2016, Value stocks rallied some 8%. This reflation trade was short-lived. Due to Trump’s failure to garner significant support amongst the Republicans (e.g. the Obamacare debacle), bond yields retracted as hopes for a speedy fiscal stimulus package fizzled and Value stocks – which are tethered to economic sentiment -retreated.
Value stocks during the pandemic
After the world came to a virtual standstill in 2020, the mood was definitely risk-off and Covid fears drove Value stocks to near-record lows relative to Growth stocks – many of which were key beneficiaries of the stay-at-home theme (think Technology stocks that permitted teleworking, online retailers, and social media networks, as all interaction moved into the digital sphere). Central banks adopted “whatever it takes” policy stances to prevent lasting economic scars from a simultaneous supply and demand shock, and interest rates were cut (bad news for banks). Across the whole of 2020, the S&P 500 Value index delivered investors total returns of just 1.4%; well below the 16.5% returns of the entire S&P 500 index and in a different orbit to the 33.5% returns offered by the Growth index.
But the tables seemed to be turning at the end of the year. In November, as vaccine developments gave some light at the end of the tunnel, Value stocks on the S&P 500 delivered a total return of 12.9% against 9.7% for Growth. In December, Value delivered 3.5% – only slightly short of the 4.1% return of Growth stocks.
Value stocks in 2021
The inoculation drive against Covid-19 is underway worldwide and major economies continue to benefit from an unprecedented symbiosis of fiscal and monetary stimulus. This is especially so in the US, where every adult was to be eligible for vaccination before the end of April, and where another $3 trillion in fiscal stimulus looks to be on the cards. At the same time, savings rates amongst consumers, who have been unable to spend for the best part of a year (especially on services) are high. As such, a growth spurt is expected and economists have been busy revising up their expectations. Some even purport that we might expect an economic boom reminiscent of the Roaring ‘20s.
Amid bullish economic expectations which incorporate the prospect of higher inflation, higher interest rates and higher government bond yields, a Value-oriented portfolio is consistent.
Amid bullish economic expectations which incorporate the prospect of higher inflation, higher interest rates and higher government bond yields (a scenario which is more evident in the US than in Europe), a Value-oriented portfolio is consistent. Take banks, for example, a typical Value play: steepening yield curves and improved economic activity bolsters their profitability. On the contrary, Growth stocks, which derive much of their value from expectations about future earnings, are vulnerable to rising inflation expectations and increases in bond yields.
We have already witnessed some rotation from Growth names into Value, though the latter is still clearly cheaper in terms of valuations. As the stay-at-home theme is gradually replaced by a new narrative of “reopening and recovery” we see potential for Value stocks to catch up further.
What about Europe?
Europe is home to a concentration of Value stocks and could eventually enjoy outperformance as the recovery unfolds and bond yields tick upwards. However, for now, the problem is that the European earnings outlook is very much dependent upon vaccines and the reopening timeline. In Europe, the pathway out of the pandemic seems a lot less straightforward than elsewhere, and if there is a sudden reversal of optimism or a downturn in data, it would be painful for investors to get caught on the wrong side of the Growth/ Value trade.
All in all, the rise of Value stocks as of late may seem strange given that the economy is not yet out of the doldrums. However, this highlights an important point: the economy and markets are interrelated but do not move in lockstep. Markets routinely adjust in anticipation of economic change. Most market commentators characterize Warren Buffett as a Value investor. But as Buffett clearly states, a smart investor should consider both Value and Growth investing, with an opportunistic mindset when it comes to style preference, in accordance with the current context.