Value stocks could continue to lead

The recent market correction and rate hikes may give value a boost.

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Key takeaways

  • It's not uncommon for stocks to go through a correction at the start of a rate-hiking cycle, followed by a rebound.
  • Undervalued stocks have been outperforming high-quality stocks during this year's correction. Historically, value leadership has persisted in similar periods.
  • Value stocks are also currently unusually cheap, which could tip the scales toward continued outperformance.
  • One more reason supporting value leadership is that undervalued stocks tend to outperform following interest rate hikes.

While this year so far has proved challenging for investors, it has also provided clues that could help identify areas of potential future outperformance. Value stocks, in particular, have taken leadership recently. And a number of factors—including recent market performance, current valuations, and the rate-hike cycle—suggest they could be poised for continued outperformance.

Corrections are common, and so are rebounds

While they can be unsettling, stock market declines greater than 5% are a normal part of the market's cycle. Of the 42 calendar years since 1980, some 36 have had sell-offs of more than 5%, including 19 greater than 10%.* Corrections have been especially likely when the Federal Reserve starts raising interest rates: Each first rate hike in a tightening cycle has prompted a more than 5% stock market decline. But investors should remember that rebounds are just as common as corrections. Since 1980, every time the Fed has started raising rates, stocks have followed their initial drop with a gain greater than 10%.

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Value beat quality in the correction, and may keep leading

High-quality stocks—shares of companies with especially strong fundamentals—have outperformed value stocks during two-thirds of corrections, historically. This time, though, value led quality. Should investors tilt toward higher-quality stocks to take advantage of lower prices? Maybe not: After past corrections with value leadership, quality trailed value by a wide margin over the next 12 months, on average.

Value stocks remain cheap, implying further leadership

Valuation metrics also make value's leadership look sustainable for 2022. Value stocks have been consistently cheap this cycle, relative to history. Even after the recent correction, the S&P 500's least-expensive quartile trades at a historically extreme discount to its median stock, based on forward earnings yield (see next chart). Value stocks have outperformed the market more than two-thirds of the time from comparable relative valuations in the past, with average outperformance of 12%.*

Value tends to outperform after interest rate hikes too

Investors who worry about the impact rate increases will have on stocks may want to look to value for protection. As the next chart shows, value factors across the board have tended to outperform the market following Fed rate hikes. The likely reason: Rate increases usually reflect strong economic growth, which can improve the prospects of beaten-down companies with improving earnings.

Based on these dynamics, value stocks continue to appear well positioned. I believe that the current disconnect in valuation—with cheap stocks continuing to trade at extreme discounts relative to the broader market—is likely to be a more persistent driver of value stocks than many of the other macroeconomic dynamics investors are considering.

Finding investment ideas

Investors looking to increase their exposure to undervalued stocks or the value investing style can consider using the stock, mutual fund, and exchange-traded fund (ETF) screening tools on Fidelity.com. Here are some funds that appeared in the results of illustrative screens (which are not recommendations of Fidelity).

Fidelity mutual funds

  • Fidelity® Value Fund (FDVLX)
  • Fidelity® Value Strategies Fund (FSLSX)
  • Fidelity® Low-Priced Stocks Fund (FLPSX)
  • Fidelity® Value Discovery Fund (FVDFX)

Non-Fidelity mutual funds

  • T. Rowe Price Value Fund (TRVLX)
  • American Funds American Mutual Fund® Class F-1 (AMFFX)
  • American Century Mid Cap Value Fund Investor Class (ACMVX)
  • Heartland Mid Cap Value Fund Investor Class (HRMDX)

Exchange-traded funds

  • Fidelity® Value Factor ETF (FVAL)
  • SPDR S&P 1500 Value Tilt ETF (VLU)
  • Vanguard Value Index Fund (VTV)
  • iShares Russell Mid-Cap Value ETF (IWS)

The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange-traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.

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She uses history to share probability analysis on the US equity sectors.

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