Value stocks had been left for dead. Their revival could be the real deal.

  • By Daren Fonda,
  • Barron's
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

Is the great value-stock rotation finally upon us? Some signs indicate it is here, and it would be about time for fans of inexpensive stocks.

Value stocks are acting like a tightly wound spring that has started to uncoil, according to a report out Monday by Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch. Value has outperformed momentum by 9 percentage points in September. That is the widest divergence in performance between the two factors (or stock attributes) since 2010, she writes. And it could represent a major shift in sentiment and positioning away from higher-growth momentum stocks toward the market’s cheaper names.

Subramanian isn’t the only analyst highlighting a shift to value. According to a report also out Monday by Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, we are seeing “a massive rotation away from growth-style factors toward value-style” stocks. Such shifts are typical in the late stages of an economic expansion. But this one may also be attributable to technical market factors, reflecting an “unwinding of excessive positioning in growth stocks,” she writes.

Subramanian highlights several reasons why value may “take the reins from here.”

For starters, value and momentum are like opposite ends of a pendulum: When one side does well, the other one doesn’t. That is called a negative correlation, and it is now at extreme levels. Since 1986, when correlations between value and momentum have been this wide, value outperformed 77% of the time over the next 250 days, according to Subramanian.

Value also tends to outperform when macroeconomic data start to recover from depressed levels. Economic slowdowns during a recovery typically last eight months and we’re now in the sixth month of one such phase, Subramanian writes. “The next phase is ‘recovery’ during which value typically outperforms,” she says.

Another positive is that value does well when corporate profit growth reaccelerates. Investors become “more price sensitive amidst an abundance of growth,” Subramanian says. Earnings growth is expected to hit bottom in the fourth quarter of 2019 and then reaccelerate into 2020, according to BofAML estimates.

That should tee up outperformance for value stocks. Since 1982, value stocks have outperformed growth by an average of 3 percentage points when profit growth has been accelerating, according to Subramanian. The Russell 1000 Value Index (.RLV) returned an average 16% during those periods, compared with 13% for the Russell 1000 Growth Index (.RLG).

Finally, value is cheaper than usual. The Russell 1000 Value Index trades at about 17 times trailing earnings compared with 27 times for the Russell 1000 Growth Index. That 10-point gap is one of the largest divergences since the global financial crisis.

Granted, investors in value stocks have been patiently waiting to see some outperformance. Over the past three years, the iShares Russell 1000 Value exchange-traded fund (IWD) returned an annualized 10.2% compared with a 17.5% annualized return for the iShares Russell 1000 Growth ETF (IWF) and a 17.7% annualized gain for the iShares Edge MSCI Momentum Factor ETF (MTUM).

Momentum and growth have outperformed value over the past 5- and 10-year periods, too.

Investors should also bear in mind that the market overall looks wobbly. Morgan Stanley recommends that investors underweight U.S. equities, in part because economic and earnings growth have slowed materially and are “apt to weigh on U.S. stocks in the third quarter.” The firm’s year-end target for the S&P 500 (.SPX) is 2,750, well below Monday’s midday price of 2,994.

Japanese and European equities look more attractive and should benefit from fiscal stimulus that will help push up valuations, Morgan Stanley says.

Stock returns may be superior abroad than in the U.S., in other words, even if the pendulum does finally swing in value’s direction here.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Print

For more news you can use to help guide your financial life, visit our Insights page.


Copyright © 2019 Dow Jones & Company, Inc. All Rights Reserved.
Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.