Value stocks are back in vogue, for now

Money managers and individual investors step up buying of banks, manufacturers and other value stocks.

  • By Michael Wursthorn,
  • The Wall Street Journal
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Wall Street says the art of buying cheap stocks is making a comeback—for real this time.

Money managers and individual investors this month stepped up their buying of shares of banks, manufacturers and other value stocks—often defined as companies whose shares trade at a low multiple of their book value, or net worth.

The renewed interest has pushed the S&P 500 Value index (.SVX) up 11% over the past three months, more than double the increase of its growth counterpart. The spurt of gains has lifted the value index ahead of the S&P 500 Growth index (.SGX) for 2019 and put it on pace for its strongest year since 2013.

Shares of Bank of America Corp. (BAC), Citigroup Inc. (C), Caterpillar Inc. (CAT) and United Technologies Corp. (UTX) have been among the biggest beneficiaries, all climbing more than 17% in the past three months.

A growing number of investors say the rebound, which started in September and accelerated recently, has the potential to carry on and close the chapter on a decadelong stretch of dismal performance.

This is by no means the first time investors have heralded a bounceback in value investing, only to quickly see the trade fizzle out. Value stocks have lagged behind shares of fast-growing companies throughout much of the decadelong bull rally. The S&P 500 value index has risen 142% over the past 10 years versus 230% for large growth companies. (The S&P 500 (.SPX) has climbed 185% over that period).

Some investors and analysts argue this time is different.

Measures of investment sentiment have improved as fears of a recession have abated, corporate profits are expected to rebound, and trade tensions between the U.S. and China have shown signs of improving.

More important, value stocks are trading at some of their most attractive prices in years, analysts say.

Brian Belski, chief investment strategist at BMO Capital Markets, said the valuation gap between value and growth stocks hit an extreme level in mid-2018 and has grown further since then, helping make value stocks appear inexpensive again.

Analysts at Bank of America add that value stocks are trading at one of their cheapest levels relative to momentum stocks, which investors purchase because they have been rising. The only other times the discount was this steep was in 2003 and 2008, the bank said. Value stocks then outpaced momentum stocks by 22 percentage points and 69 points, respectively, over the next 12 months.

Price-to-earnings ratios, a measure of how expensive a stock is, for value- and growth-oriented sectors back up the disconnect. Financial stocks trade at 12.7 times their expected earnings over the next 12 months, around their five-year average, while industrial stocks trade at 17 times. That is below technology stocks and the broader index, which trade at 20.7 times and 17.7 times, respectively.

“Growth has crushed value over the past five years,” said Ronald Temple, head of U.S. equities at Lazard Asset Management. “But we reached a point where the valuation divergence between growth and value got extraordinarily high.”

Mr. Temple isn’t the only one who believes value is due for a comeback.

A recent Bank of America survey found more than a third of the 230 fund managers they polled said they expect value stocks to post better returns than growth stocks over the next 12 months. That is an increase of 21% from the October survey and the third-biggest month-over-month swing since 2007, the bank said.

Value stocks’ losses over the past two years have been “irrational,” Clifford Asness, co-founder of money-management firm AQR Capital Management LLC, said in a recent note to clients. Fundamentals didn’t worsen, but prices did, he said, as investors continued to focus on growth and momentum stocks. He added that value stocks’ slog in the first eight years of the rally was more justified.

The divergence grew wide enough that Mr. Asness said his resistance to adding more value stocks lessened.

“Unlike a few years ago, it is indeed time to ‘sin a little’ and up the value weight somewhat,” Mr. Asness said.

But value stocks can’t rally on price appeal alone, analysts and investors warned. Improving sentiment on the economy, trade and corporate profits helped nudge investors back into buying riskier assets in recent weeks. Those factors need to remain in place for a sustained rotation into value stocks.

“We were in a period of extreme economic uncertainty,” said Adam Agress, a portfolio manager who helps oversee Goldman Sachs ’ midcap value fund. “As people have gotten more comfortable with the outlook, they’ve rotated capital out of those defensive and growth sectors,” with investors more willing to load up on riskier assets, he said.

He added his fund recently bought shares of some transportation, semiconductor and gaming companies and sold utility, real estate and consumer-staple stocks.

“These are all industries that benefit from the economic outlook improving, but were priced for a high probability of a recession just a few weeks ago,” he said.

Fund managers broadly increased allocations to bank stocks this month, notching the biggest month-over-month change in exposure in more than a year, Bank of America said.

The recent turn of events has caught the attention of growth managers who are willing to blend the lines between the two investing styles. Lew Piantedosi, who manages Eaton Vance’s growth fund (EALCX), holds big stakes in Inc. (AMZN), Google parent Alphabet Inc. (GOOGL) and other growth stalwarts. But the fund also has stakes in JPMorgan (JPM) and Bank of America.

“For a tactical growth manager, large U.S. banks are probably the best way to play the market if you don’t feel a recession is coming in the next 18 months,” Mr. Piantedosi said. “They’re the cheapest stocks around.”

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