It’s been a better time for value stocks, but markets have been here before. Can their recent strength endure?
- The ‘dash for trash’ has been a feature of many stock market recoveries.
- As PMI numbers start to recover, cyclical sectors tend to outperform.
- It is a notable change from the ‘growth at any price’ attitude of investors in recent months.
In mid-May, under the laws of contrarian investing, the departure of a handful of high profile value managers seemed to suggest value investing had reached its nadir. Since then, value has staged a mighty recovery, with areas such as transport, energy and materials rising sharply. Now, investors have a different question – is this a genuine resurgence for value? Or just a ‘dash for trash’?
The ‘dash for trash’ has been a feature of many stock market recoveries. As the valuations of good companies no longer look as compelling, investors revisit beaten-up areas of the market, ‘bottom-feeding’ for outsized gains. In general, it is a tough time for active investors with any sort of discernment because it tends to favour poor companies who have survived by the skin of their teeth.
This characterisation of the recent market rally isn’t quite accurate. Certainly, cyclical companies have made more progress in this environment, but there is still little appetite for weak and indebted businesses. Equally, there are sound reasons for some resurgence in cyclical companies. Research from Barclays shows that as PMI numbers start to recover, cyclical sectors tend to outperform. Combine that with their weaker share prices and some of the share price moves may be justified.
This has been a better environment for value. Investors appear to be looking at the ‘P’ (price) as well as the ‘E’ (earnings). This marks a distinct change from the ‘growth at any price’ attitude of investors in recent months.
Will it last? The rally is only very short term and we have been here before. Value stocks staged a rally in September last year, which proved only a short-lived bounce in a painful decade for the strategy. However, it is worth noting the views of experienced value investor, Kevin Murphy at Schroders. He points out that good businesses with strong balance sheets that have been overlooked by most investors - ‘value stocks’ - tend to be the first to find a floor after a market rout– at which point they gradually outperform on a relative basis. This would support the view that the rally can endure.
He also notes that that “before markets can head upwards once more, investors need to work through the stages of panic, despair and, finally, capitulation – the point of maximum hurt when almost everyone throws in the towel and sells up.” Much of the view on whether value can continue its run may depend on whether investors believe we’re through that point. Time will tell.