Why the stock market will soon favor value investing again
4 reasons why the switch to value stocks and away from growth plays may have already started
by Ben Fischer
The global markets have encountered an era of financial repression since the beginning of 2009 — a period of low interest rates and risk-encouragement that has led to a blissful time for growth investing. The market has awarded a scarcity premium to companies that can grow in this environment of limited economic expansion prospects. At the same time, the market has paid less attention to traditional value factors like price-to-earnings (P/E) ratios and dividend yields — despite the fact that these factors have provided sizable return premiums over the long term.
Clearly, everything has its season, and it is fair to say that it has been a long, cold winter for value investors who are committed to the style. Indeed, value has not been this out of favor since the high-flying days of the tech bubble in the late 1990s.
It is important to remember, however, that growth/value cycles tend to be mean-reverting and, on average, have lasted between seven and 10 years from trough to peak. With the growth style now in its ninth year of relative outperformance, the current phase of this cycle may be drawing to a close, and we may soon be likely to enter an environment that once again favors value investing.
Once this shift in the market occurs, as shown in the accompanying charts, yesterday’s laggards could become tomorrow’s leaders — and investors may want to be positioned accordingly. Of course, no one has a crystal ball that says exactly when the cycle will flip, but there are some signs that a shift may already be occurring, including:
Higher U.S. interest rates. History shows that shortly after an initial rate hike, value stocks have outperformed in a persistent and pervasive manner. It is worth noting that “liftoff” for the current rate-hike cycle occurred in December 2015.
A weakening U.S. dollar. Value indexes are skewed toward market segments like energy, industrials, and “old tech”, which derive significant revenue abroad. The U.S. dollar DXY, +0.37% (UUP) has been losing value, which may provide these companies with an earnings tailwind.
A recovery in the high-yield bond markets. Value is inversely correlated with U.S. high-yield spreads. These spreads are currently falling thanks to better credit conditions which signal that the worst may be behind us.
Strengthening commodity markets. Value outperformance is positively correlated with rising commodity prices.
Given today’s market conditions, it seems prudent to keep exposure to value-oriented investments focused on income from dividends and low-valuation P/E multiples.
Courtesy of Allianz