In our last piece, we highlighted the underperformance of Value stocks versus Growth stocks over the past decade, in both emerging and developed markets. Here we look at the Value recovery, the reasons for the rotation and why we believe the reversion still has a way to go, given current tailwinds.
In hindsight, the Growth rally seemed unsustainable as it was not backed by fundamentals and was triggered by a period of low interest rates. The rotation to Value started in November 2020 and took place in four key stages. We look at the impact of game-changing developments since that time, such as the COVID-19 vaccine, the announcement by the Chinese government to regulate the country’s internet sector and the Russian invasion of Ukraine.
Further support for the rotation was demonstrated by the most expensive stocks in the emerging markets (EM) universe starting to look stretched, having become significantly more expensive and being of lower quality than various cheaper names. Whilst the most expensive names on a PBV basis traditionally deliver the highest ROE (as investors pay for Quality names), at the height of the technology bubble this relationship disappeared. The spread of PBV peaked in October 2020 at a very high level, whilst the spread of ROE narrowed to the lowest level since 2002.
This anomaly couldn’t last long and it took just months for the most expensive stocks to sell off. However, we believe the spread is still excessive and there is still a long way to go in the de-rating of expensive stocks. In our view, the rotation will continue on the back of valuations that remain excessive, disappointing earnings figures emanating from the technology sector and re-ratings in financials and cyclicals, with financials that suffered in a low interest rate environment likely to benefit from inflationary trends.
Style performance is likely to remain volatile in the coming years, and we understand the importance of selective investment as the world faces significant challenges. Our top-down thematic research helps identify areas of structural growth, whilst avoiding dying industries and value traps. An example of this is green infrastructure, which we have identified as a key theme within EM. We see electric vehicles, renewables and transition materials as the best ways to gain exposure. These areas are all segments of the market that have a high composition of Value names, and with the imperative to spend as a tailwind, Value as a style could continue to rise.
We remain positive that there are many opportunities for Value investors, even within what are traditionally Growth sectors, and particularly in smaller and undiscovered companies and segments. If these are thoroughly researched, they can offer significant upside opportunities for investors.
To learn more, read the full piece here.