Is this the start of a style rotation or another false dawn?

Following news of vaccine breakthroughs, companies that were hardest hit by lockdowns, such as airlines and leisure and hospitality businesses, have rebounded dramatically.

New hope for the end of Covid-19 sent stock markets higher in the last couple of weeks as both Moderna (NASDAQ:MRNA) and Pfizer (NYSE:PFE) announced that they had created 90% to 95% effective vaccines.

The first announcement, from Pfizer on 9 November, sent the FTSE 100 up 5% as investors envisaged an end to the pandemic on the horizon.

The types of companies that reacted most strongly to this good news, however, reignited hope among value investors that recovery stocks could finally come back to life. Those companies that were hardest hit by lockdowns, such as airlines and leisure and hospitality businesses, rebounded dramatically.

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“Is this the start of a major rotation?” asks Johanna Kyrklund, chief investment officer and head of multi-asset investments at Schroders. “Quite possibly. We may finally have found the catalyst to spark a move away from the ‘stay-at-home’ stocks that have benefited from lockdown, towards recovery stocks.

“There would no longer be a need to pay a large premium for the few areas for growth, if all sorts of companies return to growth as the economy recovers.”

Beware value traps

Also optimistic is Tony Yarrow, co-manager of the TB Wise Multi-Asset Income fund. He notes that cyclical value sectors suffer most in a recession, and the pandemic has “delivered the swiftest and deepest recession since the 1930s”. It makes sense, then, that the promise of a vaccine and eventual economic recovery would boost value stocks, but investors must be selective, he warns.

“It seems reasonable to expect a recovery from here, particularly given the supportive actions of governments and central banks. In such circumstances, it would not be too much of a stretch to expect sectors exposed to a recovering economic cycle to rebound from their current depressed levels,” says Yarrow. “We need to make a distinction though. The value sectors include some that might be expected to recover with the economy and others that have been disrupted to the point where they may never recover at all. Value investors always need to distinguish between genuine bargains and value traps – that caution was never needed more than it is today.”

This time is no different

But, after so many false dawns for value investing, not everyone is convinced that a vaccine will be enough to trigger a sustained rebound for beaten-up cyclical stocks.

Rathbones’ head of multi-asset investments David Coombs says that there are “tectonic shifts” that would need to take place for a real value resurgence to happen, such as above-trend GDP growth, inflation, wage growth and interest rates at 3% to 4% - and this is not that. “I don’t think it’s different this time. We always see these rotations as a risk factor, actually, and we see this rotation as a short-term risk issue rather than a medium-term opportunity.”

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Coombs does not buy airlines and hotels because these stocks don’t fit with his investment approach, but he recently rotated into banks, oil companies and industrials and has since moved back out again, taking profits in some of those names that have risen sharply.

Recovery in the worst-hit sectors such as airlines will be “messy” and could take years, he says, with consolidation likely. “Yes, there will be a lot of money to be made in the winners in those damaged sectors, but that’s not my game. We will continue to invest in more growth areas over the medium term. That’s going to be the better place to invest because you’ve got more visible future growth and profits.”

But is he concerned about the high valuations in some of these high-growth names? Coombs is not invested in names such as Netflix (NASDAQ:NFLX), Uber (NYSE:UBER), Facebook (NASDAQ:FB), Tesla (NASDAQ:TSLA) and Spotify (NYSE:SPOT), some of which are trading at very high levels, because he prefers “real tech” companies such as Adobe (NASDAQ:ADBE) and Microsoft (NASDAQ:MSFT) that are working to improve productivity for their customers. They are also trading at more sensible valuations than some of these “tech-enabled” businesses.

Meaningful comeback?

Ketan Patel, fund manager on the Amity UK Fund at EdenTree Investment Management, also thinks that rising inflation and interest rates will be needed if value investing is to make “a meaningful comeback” after a decade in the doldrums.

“The pandemic has been highly disruptive, but the unprecedented actions by central bankers and governments has led to markets being flooded with monetary stimulus and this doesn’t augur well for inflation or interest rates,” he says.

“Those who favour value will continue to make a case for value outperforming in the very long term, but the last decade has proved to be very harmful to value investors and we are likely to see very few, if any, catalysts for a meaningful change.”

It’s easy to oversimplify and get caught up in the binary growth versus value argument, but Patel suggests this is probably not that helpful to investors. Instead, he advocates finding companies that offer growth at a reasonable price and holding on to them for the long term.