Are value stocks dead?

//Are value stocks dead?

Are value stocks dead?

How is it that stock markets can continue to hit new highs when the world is facing so much uncertainty? From the toll of natural disasters to an increasing array of political populism and saber-rattling of North Korea, nothing has yet sent markets off course. The fact is that financial factors still matter more. But when we look past the broad averages and push a little deeper, we can see asset class diversion that puts a different story behind the numbers.

We have been keeping track all year of the performance gap between growth and value stocks. The former is up more than 19% while the latter has only managed a 5% gain in 2017*. Why has growth done so well while value has not? There are several explanations for the difference and there is something we can do about it.

A small part stems from value’s strong performance in 2016 when it was up over 18% vs 7% for growth. Some of this is simply mean reversion.

A more meaningful explanation derives from economic growth. Growth typically does better when economic growth is modest, while value typically does better when economic expectations are generally rising. Our economy is still growing at about the same 2% average we have seen since 2008, a bit of a letdown from higher expectations held at year-end. Investors put a premium on companies that can generate above average growth in any environment, which explains why technology is the only sector to exceed the overall returns from growth benchmarks. This reflects how much a few names are pulling the market along.

As a result, the relative position of growth and value has shifted this year. The associated graph explains this through the ratio of value PE’s over growth PE’s. Historically the ratio averages 0.77x. It is not an ironclad rule, but when the ratio moves higher, value typically performs better than growth and vice versa. We can see that the ratio moved higher in 2016 in tandem with the strong value performance, and reversed itself as growth took over in 2017. We currently see a ratio around 0.70. Value hasn’t been this cheap to growth in some time.

We also have seen a 3%+ GDP growth in the second quarter and forecasts for third quarter are around 2.5%. If Congress can agree on a plan to cut taxes, that may give companies and individuals means to invest and spend, putting economic growth on a higher, and more sustainable level. This would certainly put a shine back on value stocks. Given the impressive run of growth in 2017, if your investment guidelines allow, it would be wise to consider reallocating some of those gains back to work in value names.

Relative value is a poor short-term timing mechanism, but at some point investor preferences will shift again. Value stocks are not dead.

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By | 2018-02-22T09:30:22+00:00 September 22nd, 2017|Market|0 Comments

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