How long can you back a value rally?
3 May 2021
Darius McDermott, managing director, FundCalibre considers whether the current outperformance of value has longer legs than may be expected.
Having spent the past few years wondering when the bull market would ever end – only to be plunged into the worst global recession since the 1930s in the first quarter of 2020 – the life of a value investor has not been an easy one in the past decade or so.
Save for the odd reversal (such as in 2016), the global value index has underperformed the global growth index by some 135 per cent* over the past 10 years. The question was not whether value was out of favour – but whether as a style it had become obsolete.
The result was a smaller pool of managers staying true to the investment style. Those who did adopted the mantra “a catalyst will come and when it does, value will rally hard”. This finally came by virtue of the vaccine bounce in early November 2020 and, since then, the tables have been turned with value outperforming growth**.
Value rallies have tended to be fast and furious in recent times – it’s been almost a case of blink and you’ll miss it. The trillion-dollar question is whether the re-opening of the global economy will add further fuel to valued-led sectors like financials, insurance, retail and utilities? By contrast, pessimists would point to there being little or no inflation in the system and a significant amount of pent up demand which could be just as beneficial to growth.
The first thing to point out is that, while we’ve seen a strong rotation into value recently, it was from historical lows, with recent returns nominal compared to the past decade of growth outperformance – so potentially there is scope for it to go a long way back to mean. However, much of the trade is predicated on inflation fears and the potential for central banks to raise interest rates – although they have repeatedly said they are unlikely to do this.
We also have to understand the drivers behind the low interest rate, low growth world – which caused the quality growth stocks to outperform – haven’t changed. Demographics remain poor in developed markets, debt levels are high and productivity is flatlining – making it difficult to justify a long-term value rally.
There are, however, some areas which are cheap for other reasons. One of these is the UK, which has been under owned globally ever since the Brexit vote, as global investors sought to avoid the uncertainty it might create. Now this is mostly settled, it should – incrementally – bring in allocators and therefore ,the UK market has the potential to make up some lost ground.
Fidelity Special Values manager Alex Wright says if value was to continue to outperform, the degree of outperformance could be very substantial, given how bifurcated the market currently is. He says he is particularly confident on the medium-term outlook – not only because of the number of investment opportunities on offer, but also because they do not have to compromise on quality***.
He says he typically invests in companies with lower returns on capital with a view that those would be improving on a two-to three-year view, but he can currently invest in businesses with already above-average returns on capital. The additional anomaly is Alex is tapping into companies that are actually upgrading their earnings guidance but whose valuations remain attractive.
I think it is hard to make a strong judgment on value beyond the next six months – for now I feel there is a bit more scope for outperformance given there is a strong chance the US 10-year treasury yield will continue to rise, based on inflation expectations. If you add the reopening trade into the mix for the likes of the UK and US, then we could see inflation tick up, which clearly benefits the value names. The important thing to remember is that inflation will not be particularly strong and, for that reason, we believe there is merit in having some value names without making a major rotation away from growth.
I recently listened to a presentation from Schroder Global Recovery fund manager Nick Kirrage, who pointed out that while the rotation and subsequent sharp-rally we saw in November 2020 might have been a flash in the pan – every value rally we’ve seen since 2016 has gotten larger, more significant, savage and violent. He says this makes value the insurance policy investors simply cannot go without regardless of their view on markets. It’s hard to argue against this point.
Those who are backing the value rally may want to consider the likes of the Schroder Global Recovery fund or, for a direct UK play, the ES R&M UK Recovery fund. If you’re more cautious you may prefer a more style agnostic vehicle like Fidelity Global Special Situations, which has a proven track record of delivering consistent returns in all market conditions.
*Source: FE fundinfo, total returns in sterling, MSCI ACWI Growth and MSCI ACWI Value, 30 March 2011 to 31 March 2021
**Source: FE fundinfo, total returns in sterling, MSCI ACWI Growth and MSCI ACWI Value, 9 November 2020 to 31 March 2021
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
This article was first published in the May 2021 issue of Professional Paraplanner.
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