To see something more clearly, sometimes you need to take a step back. Growth’s outperformance versus value has been undeniable over the past decade, but viewed over the last 20 years, it’s clear this is simply a reversal of the value-driven super-cycle that dominated in the decade leading up to the 2008 financial crisis. In recent weeks, suggestions the pendulum could be swinging back toward value have been a source of considerable interest to investors.
In Europe, portfolio manager Fabio Riccelli views the thinking about the recent value outperformance as misleading, because much of it has come from the narrow group of cyclical stocks which have done well since April 2020, with the broader ’value’ segment (including financials, energy, and materials) outperforming only from November.
But the rally among cyclicals since April now means they are no longer cheap on any measure of recovered earnings. For example, European value stocks are already back to average price-to-book levels they last saw in 2009. Having said this, growth isn´t cheap either. Many of the more beta geared tech stocks continued to do well throughout much of last year, and trade at significant price-to-earnings premium relative to history.
Fabio concludes that all this is cause for caution about the outlook for equities in general. Economic recovery is already priced in for much of the market, and we will need to see economic growth accelerate beyond this to see meaningful upside. This means that the next 12-18 months could be an environment much more suited to stock picking, rather than broader sector calls. There are still valuation dispersions in an already expensive stock market.
In China, by contrast, portfolio manager Jing Ning takes a somewhat contrarian stance, seeing support for a growth-to-value rotation in China’s macro backdrop. In this view, the momentum in China’s growth stocks has been driven by excess liquidity and strong retail participation, which have led to an excessive widening of the gap between valuations and fundamentals. A narrow band of stocks rallied over the past year, mostly in the technology and internet related names.
It remains difficult to pinpoint when we might see a meaningful mean reversion from growth to value, but China’s macro backdrop offers support for such a rotation. Fiscal measures benefitting infrastructure investment and support for consumers can be catalysts for a cyclical recovery (as indicated by robust property market data, for example). This combined with higher bond yields (a potential inflationary indicator) should underpin value sectors in China.
She believes that to see a further rotation into value, a few catalysts will need to occur. First, the earnings cycle would have to turn positive on improving macroeconomics in the recovery from the Covid-19 outbreak. In other words, we need to see positive earnings revisions from a global perspective. After the bottoming of an earnings cycle, the first phase of an upward turn tends to benefit traditional macro-sensitive sectors like materials, industrials and energy.
Second, inflation expectations need to turn positive. The consensus view of zero or low rates needs to change, which in turn would trigger a switch from bonds into equities; again, the likely beneficiaries here are cyclicals and value stocks.
There are some signs these shifts are taking hold. For example, demand has turned positive for commodities such as copper, aluminium, iron ore and soft commodities (like sugar, paper, and glass). This, coupled with low inventory in the system, could further underpin a broader and deeper demand recovery this year, which would in turn help stoke higher pricing and rising inflationary expectations.