Since March and April tapering and inflation concerns eased up, U.S. value stocks have regained their lost ground and are outperforming growth stocks by 40% since the vaccine announcement late 2020.
How long will last the value rally is yet to be seen. The financial crisis put an end to the 2000’s decade when value structurally beat growth. The wheel has since then turned with only three brief value rallies that failed to break out from a descending trend. Will it be lengthier this time?
Tailwinds for value stocks haven’t been that powerful for a long time. Worldwide economic reopening is fueling a surge in households demand and corporate investments, which is boosting value stocks’ revenues, margins and profits. The turn in their earnings finds further support from massive fiscal and monetary stimulus. The housing boom is also benefitting value stocks, many of them sensitive to firming credit demand and materials/machinery purchases. Besides, a weaker dollar and lower economic policy uncertainty set the condition for a catch-up in value stocks. Meanwhile, a spike in inflation and a steepening yield curve dented in growth stocks’ valuations. This cyclical boost for value stocks doesn’t look exhausted yet.
Over the longer run, the tide yet favors growth stocks in our view. Value stocks’ structural drivers look weaker than in the past, constrained by lower potential GDP growth and increased competition. Most secular trends, that were accelerated by the pandemic, tend to favor growth stocks instead.
While the value recovery could have more legs than previous rallies, increased selectivity will likely be required as we move to a mid-cycle, avoiding ageing business models. Furthermore, stocks qualifying as ‘value’ are changing rapidly. Since the vaccine news, most materials and staples are not anymore ‘pure value’, raising the weight of financials and industrials in indices. The catch-up in many value stocks eroded their ‘value’ appeal. High factors’ volatility and turnover are making indices less reliable (especially when rebalanced unfrequently) and increasingly challenging to use as investment tools.
U.S. L/S Equity managers had massively reweighted value stocks since the end of 2020, positioning on higher inflation and economic reopening. Since May though, managers in our peer group have reduced their overall exposures and taken profits on richening value and cyclical stocks. They are now neutral value vs. growth while keeping a cyclical tilt. We find that stocks’ sensitivity to the pandemic are a declining allocation driver. Instead, managers report they are increasingly focusing on stock picking and are giving up on using treacherous factor indices as hedges. Corporate activity and stocks exposed to secular trends are bigger themes. They believe markets are in a transition towards softer directionality. Given the velocity of market rotations, uncertainties from tapering and renewed retail-driven short squeezes, they see no middle ground between buy & hold (with higher volatility) and tactical approaches. Higher differentiation across stock-pickers is likely.