Market Outlook: Recovery of Value Stocks

Previous articles have elaborated on certain trends and economic activities that could result in market shifts globally and have investors adjust their portfolio’s accordingly. It is empirically evident that since the 2008 Economic Recession, global markets have been steadily (yet slowly) recovering, leading into recent boom years for bull markets. Many factors currently in play predict that high volatility growth may soon come to an end, and for the first time since 2000 it appears that value stocks may close the gap in performance relative to growth stocks.

Value stocks or value investing centres around the premise of investing in stable companies that are minimally affected by volatility of mass-psychology and the macro-economic environment. Value companies are ones which are undervalued in terms of price-earnings ratios, due to more ‘plain’ and conservative business models. The lack of sensation around these companies often diverts investors’ attention to more headline-grasping growth stocks.

The bull markets of 2009 till present have resulted in value stocks losing out to growth stocks by 35%. However, a characteristic of value stocks is that they tend to perform better during the later stages of economic cycles, which by all indications is the period that is being brought upon come 2019. The S&P 500 saw a decline of 6.49% for the month of October, and the European Stoxx 600 has fallen by 13% since its peak on January 23 of this year.

A primary driver of this recent downturn in markets are the recently discussed interest rate policies of the US Federal Reserve. Although the Federal Reserve has announced its intentions to raise interest rates since the beginning quarter of this year, the actual market effects have been delayed. Investors have now become largely convinced that the restrictive monetary policy will be pursued regardless of market implications.

The best-case scenario (continuation of the existing market trend) will only see economic expansion reach levels no more than the average for this economic cycle, as indicated by graph 1. This would make this current expansion the longest in history, as indicated by graph 2.

Given these suboptimal predictions for the future, one may assume that value stocks should show significant increases in popularity. Yet this is still currently not the case, and for two primary reasons. Firstly, growth stocks overall are largely driven by the momentum of the technology industry. Secondly, short term investing is still the common marketplace practice; value investing requires notable patience.

One important reason that value stocks are still not receiving the recognition they arguably deserve is that discount rates for future cash flows remain low because of current interest rates. However, this will undeniably change in the near future, thus will the prospect of value investing.

Another expected future development is the tightening of lending practices and the increased costs of borrowing money. Investors who have previously taken full advantage of leverage will therefore be put at a high risk, further pressuring the economy towards a downward trend.

2019 stands to significantly decrease the opportunity cost of value investing in regards to growth investing. AMSA therefore encourages investors to switch a portion of their portfolio into more value stocks and (partially) adopt a more defensive strategy. It should be noted that there are scenarios where this may come at a notable risk. In the complete absence of a recession or downturn it is unlikely that the performance of value stocks will improve in comparison to growth stocks. Furthermore, very gradual increases of interest rates, as well as diminishing geopolitical risks (e.g. Brexit and the Italian populist government) would allow growth stocks to further extend their lead.