The Reemergence of Value
- October 15, 2019
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.
DISCLOSURES
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.
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