The Growth versus Value debate is heating up again. Despite the market gyrations in recent months, our preference for Value has not changed. Here’s why we continue to see Value opportunities in the road ahead.
Colin Low | Published on 14 Sep 2022
- Our preference for Value has not changed despite market gyrations in recent months. We believe the macro backdrop, wide valuation discount gap, and relative fundamental strength to Growth should sustain the Value run.
- The macro backdrop and risk of a persistently aggressive Fed should support Value stocks’ performance. The Value factor has the tendency to outperform Growth during periods of elevated inflation and rate hikes.
- Earnings estimates continue to swing in favour of Value stocks. Value stocks have enjoyed consistent earnings upgrade throughout the year unlike Growth stocks which are facing accelerating earnings downgrades.
- Value continues to trade at a wide discount to Growth. The MSCI AC World Value index is still trading at a 50% discount to its Growth counterpart, below the historical average of 27% discount.
The Growth versus Value debate is heating up again. Growth stocks managed to outperform its Value counterpart in 3Q22 but the gap swiftly narrowed after Jackson Hole, when the Fed reiterated its hawkish commitments. Value (gauged by the MSCI AC World Value index) returned 4% while Growth (gauged by the MSCI AC World Growth index) returned 9% in 2H22 (Chart 1). Despite this underperformance, Value stocks are still the more resilient play year-to-date, declining by only -6% as compared to the -19% dive from Growth stocks (as of 12 Sep, SGD terms).
In April, we reiterated our preference for Value stocks. This stance has not changed despite the market gyrations in recent months, and we continue to see Value opportunities in the road ahead. In this article, we outline the reasons why Value has not lost steam and the portfolio strategies for investors.
Chart 1: Value has been the more resilient play this year
Value stocks are catching up again
Value’s lacklustre performance over the past few months can largely be attributed to an outwards rotation back to Growth stocks due to a combination of macro and micro factors (Chart 2). On the macro side, the cooling of inflation data and global growth momentum set the stage for the expectation of a Fed pivot – scaling back their aggressive stance. As treasury yields retreated in response to this expectation, long-duration assets such as Growth stocks rallied. On the micro side, 2Q earnings season proved to be somewhat resilient for the bigger tech companies as it reinforced the rally in tech Growth stocks.
That said, the rotation from Value to Growth stocks has faded after Jackson Hole. The Value factor has again started to strengthen relative to Growth, with Value stocks outperforming its counterpart since mid-August. We see this happening across geographical regions in both developed and emerging markets (Chart 3.
Chart 2: Underdog no more – Value has finally bucked the decade-old trend
Chart 3: Value have underperformed Growth from June to August, but things are reversing on a global level.
Value stocks remain firmly supported
Despite the lacklustre performance over the recent months, we believe Value stocks have yet to lose steam. The macro backdrop remains supportive and we see two pillars of support for the Value factor – relative fundamental strength and wide discount gap to Growth.
i. Macro backdrop still supportive of Value
Despite the recent moderation in US headline CPI, upside risk to inflation remains. While US inflation prints have moderated, we think it is too early to take comfort as i) Core CPI remains stubbornly high. Headline and core CPI will end the year at 6.2% and 3.7% respectively even if there is 0% month-on-month growth from August onwards (Chart 4), ii) sticky component such as rent (denoted in CPI report as owner’s equivalent rent) continue to post strong monthly gains (August’s saw 0.7% MoM growth as compared to the 20-year average of 0.2%), and iii) wages, a fuel for higher prices, remain robust as seen in recent job data. Beyond these factors, the potential for Russia to further reduce or cease energy supply to nations that introduce price cap is also an active risk to higher inflation.
Given the upside risk in US inflation, we also see risk of a persistently aggressive Fed – a continuation of the hawkish rhetoric. The Fed’s recent remarks during the Jackson Hole symposium reinforces this view. Our expectation of elevated inflation levels and the risk of a persistently aggressive Fed leads us to believe that the ongoing rotation to Value stocks can be sustained. This is driven by Value’s tendency to outperform Growth during periods with elevated inflation and rate hikes (see previous update).
Chart 4: Even if headline and core CPI show no growth month-on-month, inflation by year-end remains high
ii. Earnings fundamentals support Value performance
Earnings estimates continue to swing in favour of Value stocks. Despite the recent cooling of global growth, Value stocks have enjoyed consistent earnings upgrade throughout the year, with a positive 4% EPS revision year-to-date. On the contrary, earnings downgrade for Growth stocks started to accelerate since July (Chart 5) and year-to-date, the latter suffered from a negative 3% EPS revision.
This wide dispersion in earnings estimates is a clear reflection of the macro backdrop’s impact on the profitability of Value and Growth stocks. The surge in yields as well as inflation – and even last year’s economic recovery – are all supportive for sectors that are intimately related to the real economy, such as the Financials, Energy, Industrials, Materials sectors. These are sectors which the Value composition overweights (relative to the Growth factor).
Looking ahead, we expect the dispersion in earnings estimates to continue and earnings of Value stocks to remain more resilient in the current macro backdrop. This should sustain the rotation to Value stocks (Chart 6). In the event that analysts start to pencil in earnings downgrade for Value stocks, the build-up in positive earnings revision in the year-to-date may also buffer against a sharp earnings contraction.
Chart 5: Value stocks have seen positive EPS revision, while Growth stocks were hit with the opposite
Chart 6: EPS momentum still in Value’s favour
iii. Wide discount gap relative to Growth
Value continues to trade at a wide discount to Growth. Since our previous update, the MSCI AC World Value Index is still trading at a 50% discount to its Growth counterpart, below the historical average of 27% discount (Chart 7). While the valuation gap has narrowed this year, the recent rebound in Growth stocks has again widened the gap. This valuation discount continues to be seen across global equity regions as well – US, Europe, and EMs – implying that Value opportunities are still global.
In particular, the discount gap in major markets such as the US and Europe continue to be wide with the MSCI USA Value Index and MSCI Europe Value Index still trading at 51% and 62% discounts to their Growth counterparts, below their respective historical average of 29% and 70% discounts. On net, the relative valuation for Value – on both a global and country level – continues to remain attractive in our view.
At such an extreme level, the upside for Value stocks coming from the narrowing of relative valuation gap significantly outweighs its downside, even if it does not fully revert to the long-term mean. With the support from fundamentals and the global macro backdrop, as explained, we believe a further narrowing of the valuation gap is achievable – which implies more potential upside.
Chart 7: Value continues to trade at a gapping discount to Growth
Strategies for your portfolio
While some of the drivers for a Value rotation have exhausted themselves since our last update, we believe the Value run is not over. Given the reasons outlined above, we continue to see merits in Value stocks, especially in US and European equity markets where inflation risk is likely the greatest, and the valuation gap (relative to growth stocks) remains particularly attractive.
While we continue to see Value opportunities today, being exposed to just a single style has its own risk – in this case, if fundamentals do not play out or if the macro backdrop pivots suddenly. Moreover, there are merits to growth investing as we recognise that technology, which dominates Growth, will continue to play an important role in the increasingly digitalised global economy. From a portfolio level, we recommend investors to hold a combination of value and growth stocks.
For Growth exposure, we believe it is prudent for investors to remain selective. We prefer Big Tech exposure given sustainable earnings and strong balance sheets that can weather the storm. Unlike the Big Tech companies, many of the high-growth companies continue to trade at lofty valuations which may be perpetuated by earnings downgrade, amplifying the risk of valuation compression.
For Value exposure, we recommend adopting a value tilt for US and European equities through Value-oriented funds like the JPMorgan Funds – US Value A (acc) USD and the HGIF – Europe Value PD SGD. Regions with a Value slant like ASEAN and Singapore equities can also offer resiliency to a global portfolio. We recommend the Principal ASEAN Dynamic Fund Class SGD and the Nikko AM Singapore Dividend Equity SGD for active exposure, or the Premia Dow Jones Em ASEAN Titans 100 ETF and the SPDR® Straits Times Index ETF, for passive exposure.
At the sectoral level, we prefer exposure to financials and commodity-related sectors. We recommend the Blackrock World Financials A2 USD, Blackrock World Energy Fund A2 USD, and the JPMorgan Funds – Global Natural Resources A (acc) USD.
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.