The Reemergence of Value
Is this time for real?
Value investing is coming back into vogue. Over the past five years, U.S. value stocks have underperformed U.S. growth stocks by a significant margin. Through the end of the third quarter, the Russell 1000 Growth index had outperformed the Russell 1000 Value index by 5.6% (13.4% vs. 7.8%) annualized for the trailing five years ending 9/21/19. There were two false starts for the value style over that period: one in late 2017 and another in late 2018 only to revert back to growth and momentum leadership.
Now, in 2019, we are seeing another reemergence of the value style. We believe that this reemergence of value is being driven by increasing investor expectations that the economy is not going into recession any time soon. This could be a combination of the Federal Reserve = lowering interest rates to sustain economic expansion and the United States and China expressing a desire to reach a trade deal.
Whether this rotation to value holds depends on whether investors’ expectations continue to play out. As long as we remain in a Goldilocks economy—not too hot and not too cold—and the U.S.-China trade talks progress toward a resolution, we think the rotation to value could hold. Economically cyclical stocks, which make up the majority of the Russell 1000 Value Index, are extremely undervalued relative to growth stocks and should be a big beneficiary if a trade deal is reached and the economic expansion continues. Additionally, this scenario will result in Treasury yields rising and the curve steepening, which historically has also tended to benefit the value style.
For these reasons we have been a strong advocate of maintaining style diversification within the U.S. equity portion of your portfolio. The growth and momentum rally has been overextended in our opinion and value stocks have been underappreciated for an exceptionally long period of time. The Russell 1000 Growth Index was trading at a 58% premium to the Russell 1000 Value Index as of the end of August, 2019 based on the next 12 month (NTM) P/E multiple using consensus estimates.
Our views
While we believe the risk of recession has increased recently, we expect the economic expansion to continue for the foreseeable future given the strong labor market, solid retail sales and an expanding services sector. The market, on the other hand, is a forward-looking mechanism that is subject to volatility when uncertainty regarding the Fed, trade and the extent of the slowdown in global growth increases. Our overall asset class views have only changed modestly since the beginning of the year when we published our 2019 outlook. We firmly believe that inflation is at bay, fundamentals remain intact and economic growth continues, albeit at a slower rate.
Given these factors, we feel that recession risk is not a near-term concern, but it is worth monitoring as some recession indicators are beginning to flash red. For example, the manufacturing sector is contracting, profit margins seem to have peaked and the number of available jobs has decreased. We remain committed to current positioning and continue to emphasize portfolio diversification. Now could be an ideal opportunity to allocate excess cash and realized gains from overvalued investments to segments of the market we find most attractive.
The opinions expressed herein are subject to change without notice. The information and statistical data contained herein has been obtained from sources we believe to be reliable. Past performance is not a guarantee of future results. The above discussion is for illustrative purposes only and mention of any security should not be construed as a recommendation to buy or sell and may not represent all investment managers or mutual funds bought, sold, or recommended for client’s accounts. There is no guarantee that the above-mentioned investments will be held for a client’s account, nor should it be assumed that they were or will be profitable. The Consulting Group is a division of Oppenheimer Asset Management Inc. (OAM). OAM is an indirect, wholly owned subsidiary of Oppenheimer Holdings Inc., which also indirectly wholly owns Oppenheimer & Co. Inc. (Oppenheimer), a registered broker dealer and investment adviser. Securities are offered through Oppenheimer.
For information about the advisory programs available through OAM and Oppenheimer, please contact your Oppenheimer financial advisor for a copy of each firm’s ADV Part 2A.
a fee-based account program may not be suitable for all investors; anticipated annual commission costs should be compared to anticipated annual fees
S&P 500 Index measures performance of U.S. large-cap companies.
MSCI AC World ex-USA Index captures large- and mid- cap representation across 22 of 23 developed-market countries (excluding the U.S.) and 24 emerging-market countries.
LTM PE Ratio is the last 12-month price-to-earnings ratio.
Indices are unmanaged, do not reflect the costs associated with buying and selling securities and are not available for direct investment.
Risk Factors: The success of an investment program may be affected by general economic and market conditions, such as interest rates, the availability of credit, inflation rates, economic uncertainty, changes in laws and national and international political circumstances. These factors may affect the level and volatility of securities prices and the liquidity of a portfolio’s investments. Unexpected volatility or illiquidity could result in losses. Investing in securities is speculative and entails risk. There can be no assurance that the investment objectives will be achieved or that an investment strategy will be successful.
Special Risks of Foreign Securities: Investments in foreign securities are affected by risk factors generally not thought to be present in the United States. The factors include, but are not limited to, the following: less public information about issuers of foreign securities and less governmental regulation and supervision over the issuance and trading of securities. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Special Risks of Small- and Mid-Capitalization Companies: Investments in companies with smaller market capitalization are generally riskier than investments in larger, well established companies. Smaller companies often are more recently formed than larger companies and may have limited product lines, distribution channels and financial and managerial resources. These companies may not be well known to the investing public, may not have significant institutional ownership and may have cyclical, static or moderate growth prospects. There is often less publicly available information about these companies than there is for larger, more established issuers, making it more difficult for the Investment Manager to analyze that value of the company. The equity securities of small- and mid-capitalization companies are often traded over-the-counter or on regional exchanges and may not be traded in the volume typical for securities that are traded on a national securities exchange. Consequently, the investment manager may be required to sell these securities over a longer period of time (and potentially at less favorable prices) than would be the case for securities of larger companies. In addition, the prices of the securities of small- and mid- capitalization companies may be more volatile than those of larger companies.
Special Risks of Fixed Income Securities: For fixed income securities, there is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time.
Liquidity risk: Liquidity risk is the risk that you might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. When a bond is said to be liquid, there's generally an active market of investors buying and selling that type of bond.
Market risk: Fixed income securities markets are subject to many factors, including economic conditions, government regulations, market sentiment, and local and international political events. Further, the market value of fixed-income securities will fluctuate depending on changes in interest rates, currency values and the creditworthiness of the issuer.
Special Risks of Master Limited Partnerships: Master limited partnerships are publicly listed securities that trade much like a stock, but they are taxed as partnerships. MLPs are typically concentrated investments in assets such as oil, timber, gold and real estate. The risks of MLPs include concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy and market risk. MLPs are not suitable for all investors.
2758803.1