This year’s value rally looks a little different to last year’s. There are reasons to believe it may have more longevity as a result.
- Over the past three months, the MSCI World Value index has outpaced its Growth equivalent by almost 10%.
- Last year’s value rally was dominated by those companies that had been hardest hit during the pandemic, but this year’s is different.
- This value rally is broader, but will not benefit all sectors.
There can be little doubt that the rally seen in value stocks since the start of the year is building momentum. Over the past three months, the MSCI World Value index has outpaced its Growth equivalent by almost 10%. However, this value rally is likely to have a notably different flavour to its 2021 equivalent and that may mean that it endures longer.
As investors will be aware, last year’s value rally was dominated by those companies that had been hardest hit during the pandemic – the airlines, leisure and travel companies that had been priced to go bust, but, with the availability of a vaccine, looked like they would survive. Many of the traditional ‘value’ areas – mature, unglamorous, dividend-paying business – did not participate.
This year’s value rally has been prompted first and foremost by the shift in the monetary policy environment. This has shifted the risk-free rate and made the valuation of many technology stocks look unsustainable. It also improves the outlook for specific sectors, such as the banks.
It is also changing the way investors view dividends. Dividend strategies have underperformed for a number of years, but in turbulent markets, a 5% yield that can grow with inflation has real appeal. Near-term income is becoming more valuable.
However, rising rates are not the only factor at work. The energy sector has its own specific dynamics. The world has rediscovered its need for fossil fuels, which has revived many unloved energy companies. Shell and BP have announced bumper profits, so also have earnings momentum driving their share prices.
Not all value companies can thrive in this environment. Deep value companies where there is an element of distress may be more vulnerable to inflation. This is an environment where the strong are likely to get stronger. Not only can they pass on price rises to customers, they can negotiate better terms with their suppliers. This isn’t an option open to all companies.
Equally, companies that cannot growth their yield are likely to struggle to attract investors. As fixed income yields rise, companies paying static dividends may lose their appeal. This is another part of the ‘value’ complex that is unlikely to move higher.
This value rally is more complex and nuanced than the 2021 ‘recovery’ rally. Different types of stock are doing well. This should give it more longevity, but there are also pitfalls to avoid.
