Macro Research

Value is making a comeback. Can the long-awaited rally sustain?

Roaring back to life in recent months, Value is the new comeback kid. The spot light is now on the long unloved Value style after its tremendous rally. Looking beneath the hood, we believe Value is at a fulcrum point where a sustained Value rally looks promising.

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  • Published on 24 Mar 2021

Value is making a comeback. Can the long-awaited rally sustain? | Open a FREE FSMOne account and manage all your investments conveniently in ONE place

  • A shift in macro backdrop – both rising growth and inflation expectation - is perhaps the most significant catalyst for Value outperformance.  Our macro view sees concurrent upside risk to global growth and inflation this year which provides a conducive macro setup for a sustained Value rally.
  • On the basis of upside risk to inflation and growth, we see room for 10Y treasury yields to climb. History also suggests that current spread level is only halfway to its potential peak. Taken together, potential curve steepening can signal further Value rally.
  • EPS momentum has swung in favour of Value (vs Growth) as higher EPS revision were penciled in at an increasing rate since 4Q20. Fundamental improvement may justify and support further re-rating ahead. Despite Value’s recent rally, its relative valuation (vs Growth) is close to depressed level, which implies ample room to re-rate. 
  • Value might be at a fulcrum point where a sustained Value rally looks promising. Considering the run up in cyclicals, leaning into the Value factor may end up being a more robust expression of the ‘Reflation trade’. We see great merits in introducing Value into the portfolio and believe a blended-style may be the most ideal in the current market narrative.

Value, the comeback kid


Roaring back to life in recent months, Value is the new comeback kid. The spot light is now on the long unloved Value style after delivering a fresh beating to its Growth counterpart. Plagued by languished performance (vs Growth) for decades (chart 1), the Value rotation was revived last year as investor’s flocked towards beaten down ‘normalisation’ stocks. 

The laborious comeback began around early Nov ‘20 where a brutal rotation kicked-off and Value outperformed its Growth 'rival' (chart 2). In fact, the recent rotation away from the latter and into the former was so sharp and violent that many are questioning its sustainability.

Looking beneath the hood of this recent rotation, we find compelling reasons to believe it has substance, unlike the false dawns witnessed last year. For a start, the Value rally is fueled by an early shift in the macro backdrop – a primary catalyst for previous Value runs. As we protract our views ahead, we see variables – both major and minor – aligning for a sustained Value rotation (as outlined below), lending credence to our believe that Value will be a major theme this year.

Chart 1: Value has largely underperformed Growth since ’07…


 

Chart 2: …However, Value made a valiant comeback after Nov ‘20




Shift in macro backdrop empowers Value


The Value composition, for decades, has overweight-ed inflation-sensitive, cyclical sectors (Financials, Energy, Industrials etc.) while underweight-ed defensives and secular growers (Tech, Comms. Services etc.) (chart 3). This tilt implies that Value excels during periods of rising growth and inflation expectation, typically in a recovery phase. In fact, this intimate relationship is clearly visible through strong positive correlation between returns for Value and the two macro variables (chart 4 and 5). 

History concludes that a shift in macro backdrop is perhaps the most significant catalyst for Value outperformance. Occasionally, there might be short-term dislocations whereby a Value rally was triggered by either rising growth or inflation expectation. However,  it is essential for the presence of both to engender a sustained Value rally. 

Again, it is no coincident that Value led the market coming out of almost every crises as both rising growth and inflations expectation are markedly present during the recovery phase.  

Given our 2021 macro view of i) above-consensus global growth, ii) rising inflation, with risk tilted to the upside in 2H20 and iii) the present state of the business cycle – recovery  phase, we see a conducive macro setup for a sustained Value rotation in 2021. In particular, a faster vaccination progress and supercharged US fiscal stimulus has lifted our 2021 growth expectation and more importantly, lend confidence to a sustained Value rally.


As we also observed, much of the re-opening basket of stocks currently falls under the Value criteria. These stocks have an impetus to outperform current Covid champions (tech stocks) should global recovery plow ahead without hiccups (our macro view), thereby adding a kicker to the Value rally.

Chart 3: The Value composition primarily overweight inflation-sensitive, cyclical sectors



Chart 4: Rising inflation expectation fuels Value rally…


Chart 5: …so does improving growth (ISM manu. new orders as a proxy)

 

Higher bond yields and steepening curve supports rally


On the basis of upside risk to inflation and growth (outlined above), we see headroom for 10Y treasury yields to climb before either of these outcomes - i) peaking, ii) destabilising equity market or iii) intervention by the Fed. While mounting inflation expectation will likely be the consistent driver for nominal yields this year, the potential for higher real rates could result in upwards surprise (for nominals). 

Higher back-end treasury yields should lead to further steepening of the 2s10s spread (Yield of 10Y UST - 2Y UST), as front-end rates will likely be suppressed, which can signal further Value rally (chart 6). Moreover, historical 2s10s spread trajectory strongly suggests that current level is only halfway to its potential peak, with an implied 150 bps steepening to go (chart 7). 

Chart 6: Value rotation is tracking 2s10s spread closely


Chart 7: Historical spread trajectory suggests current level is only halfway to peaking


 

Fundamental recovery - Accelerating EPS momentum and growth 


While the positive macro setup (discussed in sections above) has facilitated a re-rating towards Value, underlying fundamentals for Value stocks will have to recover to justify such a move. 

Upon a closer look at profitability of Value companies, we note that EPS momentum has swung in favour of Value (vs Growth) (chart 8). Not only has the former witnessed relatively higher EPS revision, but they were penciled in at an increasing rate since 4Q20. Value’s forward earnings growth for 2021 and 2022 is now comparable to Growth’s (chart 9), a far cry from prior years. 

Albeit skewed by low-base effect, we believe much of Value’s 2021 EPS growth can also be attributed to a cyclical EPS recovery, which is supported by its sector composition. In totality, we view the strong EPS growth and momentum as a necessary and powerful kindling for further Value rally.  

Chart 8: EPS momentum swinging in Value’s favour – stronger revision since 4Q20 

 

Chart 9: Value expected to generate comparable EPS growth (vs Growth) ‘21 and ‘22

 

Depressed valuation implies further re-rating


Despite Value’s recent rally, its relative valuation (VS Growth) remains just a thread above its 20-year low, close to -2 standard deviation below historical average (chart 10). At such depressed level, we think there is high tendency that -  i) Value’s re-rating may be sharp, ii) with notable room to re-rate, even if it fails to greet historical average, and thus, ii) the current Value rotation is likely not overstretched. 

When viewed in the grand scheme of a major Value rotation, the recent rally is seemingly in its infancy. MSCI World Value still trades at around 50% discount to its Growth ‘rival’, compared to a pre-Covid high of 60% and a 20 year-high of 102%. Therefore, we believe the recent rally is just the onset of Growth premium unwinding and the relative valuation offers a glimpse of a possible potent re-rating.

Chart 10: Ample room for Value to re-rate higher

 

The kicker – Value extending to Momentum 


Momentum, which has been residing in growth for a long time, is increasingly moving towards Value. Propelled by the ongoing Value rotation, more Value plays will be screened as Momentum as we approached end-March - the anniversary of last year’s drastic plunge in equity market.  Many quantitative model/ portfolios commonly adopt a 12-month timeframe to screen for Momentum stocks, which should see innumerate Value stocks get pick up given its strong 12m price performance.

In other words, we can expect a dramatic shift in the top quintile of momentum stocks when these model/portfolios rebalance end-March as Value displaces existing Growth names. We view this as an opportune accelerant to the ongoing Value rally and a technical support in terms of higher inflows into Value stocks over time. 

End of the mortification of Value?


While we hold much positivity for Value moving ahead, the rally is unlikely to be linear. The Value rotation may be challenged with pullbacks in the near term (which is common across history) given two things - i) investors taking profiting after the rally and ii) rebound in Growth names. We continue to monitor risks such as a disappointment in Macro data, sustained counter-rally in Growth and if/when Fed decides to address rising inflation. In our view, these should help gauge the health of the Value rally.

Having said that, we believe Value is essentially at a fulcrum point where a sustained Value rally can take flight (for reasons outlined in this article), bearing potentially powerful reward with relatively small risk. Considering the run up in cyclicals, leaning into the Value factor may end up being a more robust expression of the ‘Reflation trade’. 

As highlighted in this article (see: The battles of styles: which global equity fund should you invest in for 2021?), we see great merits in introducing Value into the portfolio. While investors are used to a growth-style approach over the past decade – rightly so, given its outstanding performance - we believe a blended-style may be the most ideal way to navigate the next few quarters.

Table 1: Value-oriented products that we favor 

*For ETFs, we recommend for investors to screen for using our ETF screener.

The Research Team is part of iFAST Financial Pte Ltd.

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