Value stocks have been anything but values in recent years. They may be worth a look now.
Betting on a rebound in value shares hasn’t been a winning strategy amid the coronavirus crisis. All stocks got hit when the market tumbled into a bear market. But even as the S&P 500 index (.SPX) made back large chunks of its losses—it has gained 26% since March 23 and is down just 12% in 2020—value stocks have languished. The $450 million Invesco S&P 500 Pure Value exchange-traded fund (RPV) has risen 24% since March 23 and is still down 40% in 2020. This dog is still waiting for its day.
That may be about to change, even if the stock market sells off again. Value stocks are looking very, very cheap relative to everything else, and they could benefit from the trillions of dollars being pumped into the economy by the U.S. government. If ever the time was ripe for the value trade to work, it is now.
It doesn’t matter how you slice and dice the category—the returns have been awful. According to Morningstar data, the nearly two dozen ETFs tilting toward large-cap value stocks have all underperformed the S&P 500 year to date, with no exceptions. That kind of underperformance has made some investors wonder if value investing, a style that had historically outperformed the market, is dead.
AQR Capital Management co-founder Cliff Asness doesn’t think so. There are good reasons for value stocks to be cheap. For instance, they tend to have lower profitability and more debt than expensive peers. But they aren’t in particularly bad shape today compared with the past five decades. Investors are simply underpaying “more than usual” for what they hate, says Asness, and that mispricing is ubiquitous across different sectors, market caps, and value metrics.
In fact, Asness notes that valuation spreads between the market’s cheapest and most expensive stocks are now stretched to historical levels—wider even than during the tech bubble and the financial crisis. And even after excluding expensive megacap stocks in certain industries, the mispricing in cheap stocks still holds. The upshot: There might never have been a better time than now to invest in value stocks.
“It has certainly been excruciating getting here, but here we are, and it’s never looked cheaper looking forward,” wrote Asness last week. “This is where long-term investors make their bones.”
What’s needed is a catalyst, says Wells Fargo analyst Chris Harvey, and it might already be here—the Federal Reserve. Value stocks are generally more reliant on debt to fund themselves. When the credit markets started to freeze up in March, it was fair to wonder if these companies would be able to survive the crunch. But once the Fed started supporting the markets—including its plan to buy the bonds of investment-grade companies that had been cut to junk—the bottom for value was in.
Even though the Fed hasn’t taken any real action yet, the credit markets started thawing last month, and the difference between yields on corporate bonds and Treasuries started to narrow. That means the buy side is now willing to fund riskier endeavors at lower costs, says Harvey, which should make the highly leveraged value stocks less perilous and more attractive to investors.
Investors inclined to play a potential value bounce have plenty of options to choose from. The Invesco Pure Value ETF, for one, lives up to its name. It offers deeper discounts—at just nine times earnings compared with the S&P 500’s 20 times—and potentially higher returns if things turn around. Its top holdings include Berkshire Hathaway (BRK/B), Kroger (KR), and Centene (CNC). One downside: The fund is highly concentrated, with nearly one-third of the portfolio in financials.
For investors who prefer their value bet to look more like the market, there’s the $155 million Fidelity Value Factor ETF (FVAL), which keeps its sector weighting in line with the overall market. It has tech giants Microsoft (MSFT), Apple (AAPL), and Amazon.com (AMZN) among its top holdings, and it trades at 13 times earnings. The fund has lost just 20% year to date, better than most peers in the category.
Unlike the Invesco Pure Value ETF, the $45 billion Vanguard Value ETF (VTV) and the $15 billion iShares S&P 500 Value ETF (IVE) don’t exclude companies with growth characteristics as long as they trade at relatively cheap prices. Both funds currently have about 20% exposure to the health-care sector, with some of the top holdings, including UnitedHealth Group (UNH) and Johnson & Johnson (JNJ), sporting a valuation of 17-18 times earnings. The Vanguard and iShares funds have both tumbled 22% this year.
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