Clearly 2022 has been a painful year for investors, with very few places to hide. Most asset classes have succumbed to the challenging economic conditions of rising inflation and the threat of recession.
However, value investors have dodged that pain to a significant degree – forcing many commentators who claimed it was an obsolete investment style to reassess their views.
Inflation is often the catalyst for value to rally and in January 2022 there was the second biggest rotation into value globally of the past 50 years, while growth-driven sectors struggled – technology for example suffered its second-worst quarter in two decades.
Recent history has shown us that value rallies are short and violent – so the question many would’ve asked is: have we already missed the opportunity? But today is different, with inflation at 11% in the UK.
Even if it were to fall back significantly we would still be in a totally different environment to the one dominated by non-existent interest rates for the past decade.
I was also interested to note that the figures for a value rally are not that strong. The MSCI World Value index is up by only 5% year-to-date, while the MSCI ACWI Growth is down 17%. Factor in the performance of energy stocks in the rise in value and there are plenty of other sectors that have arguably had little to no boost in performance.
We also have to remember that between 2009 and 2021 the MSCI ACWI Growth out-returned its value peer by some 265 percentage points.
GMO Research says that while value has repriced meaningfully relative to growth there remains an extreme “valuation dislocation”, which is likely to continue to unwind.
The research firm adds that, with valuations remaining stretched, investors should be cautious when it comes to their level of exposure to market beta, adding that “one of the reasons we remain excited about the long value vs. short growth trade is that it is broadly equity neutral – a very desirable characteristic in this time of heightened uncertainty”.
ES R&M UK Recovery manager Hugh Sergeant says value stocks are still cheap relative to growth on all metrics on a global basis, including price-to-earnings (P/E) and price-to-book.
He says the market is paying quite full prices for certainty stocks (low volatility streams of profits and cash flow) and double discounting valuations for companies where there is a risk to short-term profits and cash flow.
He says: “The great thing at the moment is that the latter covers a very wide range of stocks, from deep value to high quality (but a bit cyclical), to fast growth (but uncertain short-term delivery). So, our investable universe is very large.
“Small and mid-cap equities are on bargain basements valuations. Any equity (and now bond) that has uncertainty associated with it is very depressed.”
Sergeant has been adding to real estate stocks in his portfolio, following their interest rate de-rating. He says whilst net asset values (NAVs) will need to fall to reflect yield increases, this is now more than reflected in share prices that trade at 30-60% discounts.
A recent update from Schroders shows the Shiller P/E of the cheapest 20% of global equities today is around 8x versus a 30-year average of about 14x. It has only been lower than that on two occasions in the past three decades – the global financial crisis in 2008/09 and the spring of 2020 – both of which were good buying opportunities in hindsight.
Fidelity Special Values trust manager Alex Wright says that, while the outlook sounds relatively bleak, many of the most affected areas of the market have sold off heavily and some stocks are starting to look interesting. After years of being relatively unloved, he says the UK market started 2022 looking good value and now looks even better.
One area he has targeted is financials, which currently make up some 30% of his portfolio, with names such as AIB Group, Aviva, NatWest, and Barclays all sitting in his top 10.
He feels the new rising rate environment will be transformational for the sector, boosting profits as a result. He also believes the fact many banks now have much stronger balance sheets following the global financial crisis is often overlooked.
A prolonged value rally is a rare thing in market these days, but sometimes valuations are simply too good to ignore. Value has had a better year, but only in the context to growth – historically it still looks extremely cheap.
Those wanting a pure UK or global value vehicle may like the Jupiter UK Special Situations or Schroder Global Recovery fund, while a pure income play such as GAM UK Equity Income is also an option.
Darius McDermott is managing director at Chelsea Financial Services & FundCalibre. The views expressed above should not be taken as investment advice.