While investors in value stocks will no doubt have been waiting for the return of the style for many years, Russell Investments’ Andrew Pease says that a long-overdue recovery could be on the cards.
Aided by the low-rate, low-growth environment in place since the global financial crisis, the growth style has outpaced value by the wide margin over the past decade.
As the below chart shows, the MSCI ACWI Growth has significantly outperformed its value counterpart making a total return of 271.68 per cent compared with 105.30 per cent for the MSCI ACWI Value index, in sterling terms.
Performance of style indices over 10yrs
Source: FE Analytics
“The widowmaker trade used to be JGBs [Japanese government bonds], but the widowmaker trade over the past decade has been an overweight in value and whether that’s going to turn around,” said Pease, global head of investment strategy at Russell Investments.
Nevertheless, the strategist believes the style could be on the cusp of a turnaround, having missed out on one this year.
Heading into 2020, it had looked as if markets were heading for a ‘mini-cycle’ after a 2019 dominated by the US-China trade war and central bank easing, he said.
“It looked like 2020 was going to be a year of recovery and the phrase that was being bandied about was ‘mini-cycle’,” he said. “We were already starting to see peak outperformance [of growth] and value looking historically cheap relative to growth.
“The idea was that we would see a mini-cycle in 2020 and that would lead to a rotation, finally, away from the US and towards non-US [stocks], and particularly Europe, yield curve steepening and a period of value performance relative to growth.
“That was starting to look on track through February and then, obviously, the world changed.”
However, Pease said conditions are in place once more for value to return to favour after a stimulus-fuelled surge in growth stocks.
“Everything's changing again but now we've got through Covid – although we're hitting a second wave – and we've got even more stimulus now,” he said.
“We're starting not from [the position of] a mini-cycle anymore, but a major cycle. And once we get through Covid, those major cycle properties will then start to kick in.”
He continued: “You don't get these opportunities very often, they only happen around cycles. And we've just gone through a big cycle turning point now.”
Yet the value style has continued to underperform this year, with the MSCI ACWI Value index down by 9.91 per cent compared with a positive return of 25.32 per cent for its growth counterpart, as the below chart shows.
Performance of style indices over YTD
Source: FE Analytics
Russell Investments strategist Pease said the current rally in markets – following the pandemic-inspired downturn earlier this year – was no normal one.
Cyclical value names would usually perform stronger in a recovery, he explained. However, this time it has been growthy tech stocks that have recorded some of the biggest gains.
As such, Pease said the US has become a ‘growth bet’ given the strong performance of the FAANG – Facebook, Amazon, Apple, Netflix and Google-parent Alphabet – in recent years.
“The rest of the world is overweight financials, energy and materials,” he said. “And, guess what, the value factor is overweight those things. So, value vs growth right now and US vs non-US are very similar concepts.”
However, the narrow market leadership hides another story, said Pease.
“If you take out the top five stocks in the US and you look at the S&P 495, it is still in the red this year,” he explained. “What really made a difference was technology, which has been the dominant factor in share market performance in 2020.”
Pease said the sector had enjoyed two big tailwinds.
“One was the pandemic trade,” he explained. “Everyone took out Netflix subscriptions to watch Tiger King and everyone’s [now] on Amazon Prime. They use cloud computing and bought Apple hardware to watch Netflix.”
The other tailwind enjoyed by tech stocks, said the strategist, was the discount rate effect as long-term 10-year US Treasury yields headed down towards 50 basis points.
As such, Pease said long duration technology stocks began to look even more attractive when Treasuries were yielding very little.
“Therefore, when the pandemic passes, tech is going to have a double negative,” he said. “One is the earnings boost from pandemic spending doesn’t get any better and eventually it unwinds.
“The other thing is that eventually yield curves will steepen by 20, 30, 40 basis points and that’s going to be a significant headwind for those long-duration growth stocks.
“Right now, we’re going through a second phase of the pandemic so again [the value recovery] gets delayed but once we get through this – and particularly once a vaccine is available – even if you’re a structural believer in tech, the cycle tells you that value is due for a period of catch-up.”