Value vs growth: what needs to happen for the tide to turn for value?

Value stocks have underperformed growth stocks for the past 12 years. Hannah Smith considers potential catalysts for a turnaround.

There have been a few short periods this year during which value has outperformed growth stocks, leading commentators to herald the resurgence of value. But the prophesied revival has yet to unfold, so what are the likely catalysts for value to return to form?

Over the past 50 to 60 years, the valuation gulf between value and growth has only been as wide, or wider, than it is today during the tech bubble of 2000 and the 2008 financial crisis, notes Jade Coysh, fund research analyst at Quilter Cheviot Investment Management. This means that valuations today are looking pretty extreme.

But the value-investing style has underperformed growth for more than 12 years. This is in part due to low interest rates, low inflation, large stimulus packages, the technological revolution and, more recently, the “Zoom boom” and boost to e-commerce from people spending more time at home.

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“These two types of growth companies - big consumer companies such as Amazon (NASDAQ:AMZN) and Shopify (NYSE:SHOP), and tech companies – have been performing phenomenally well year-to-date, and pretty well beforehand, and this has really hurt traditional value companies such as banks, energy and industrials,” says Coysh.

Anthony Rayner, multi-asset manager at Premier Miton, adds that the transition towards renewable energy has also helped growth stocks. Clean energy stocks have almost doubled within a year, while oil stocks have almost halved, as Covid-19 lockdowns have added to disinflationary pressures, he says.

Prolonged recovery vs dead cat bounce

So, what could be a catalyst for a turnaround for value? Well, we’ve already had a glimpse of what could happen. In September this year, value stocks enjoyed a “short, sharp bounce” and, for a couple of weeks, were doing better than growth names. Coysh suggests that this volatility is likely to continue. “A lot of this is just because valuations are so low that it doesn’t really take much for them to outperform, even the tiniest bit of positive news. But, unfortunately, it is usually quite short term.”

A prolonged value recovery will require a lot more than just a bit of good news for an individual stock or sector, she argues. What’s needed is a rise in interest rates, which seems a long way off given the direction of travel for central banks trying to support economies through the pandemic. Even a slight return of inflation would also benefit value stocks, says Coysh. Finally, a shift in the tech sector, whether through higher taxes or stronger regulatory scrutiny following the US election, although Coysh doubts the administration would take drastic action given how important these companies are to US growth.

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The race for a vaccine

Another potential driver of value could be a vaccine for Covid-19. Bank of America Merrill Lynch analysts say this year value has had its worst year since 1992, down 38%. But the reasons to own it are becoming more compelling, not least the fact that 90% of fund managers it surveyed expect a vaccine by the first half of next year, which should help lift bond yields. 

Investment strategist Sebastian Raedler says that value stocks have lagged because bond yields have not yet risen in response to improving macro data and because the two big European value sectors, energy and banks, have continued to lag.

“We expect both obstacles to fade over the coming months, as we think a maturing economic recovery is set to translate into rising US bond yields, and banks and energy are likely to outperform on the back of an improving earnings cycle,” he says. “As a consequence, we expect value to outperform growth stocks by around 10% by early next year.”

Value is not dead

While it might be tempting to avoid value altogether given its numerous false starts, diversified investors should still hold these stocks, suggests Coysh. “I’m not someone who thinks that value is dead, but I think it will just take a little bit longer for it to turn around.” She says investors should maintain some exposure because if there is a market correction and value comes back, it could happen quickly and investors could otherwise miss a big part of the rebound. Quilter Cheviot uses US value funds from Vulcan and BNY Mellon in client portfolios. 

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