Macro Research

Rise of the underdog. The comeback of US Value stocks

Value is the underdog no more. We like US Value due to the support from fundamentals, attractive relative valuations, and its underlying composition. It remains our preferred approach for exposure to US equities.

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  • Published on 09 Feb 2023

Rise of the underdog. The comeback of US Value stocks  | Open a FREE FSMOne account and manage all your investments conveniently in ONE place

  • Corporate earnings growth and earnings estimates remain in favour of US Value stocks. US Value enjoyed double-digit EPS growth, outpacing US Growth last year. Earnings revision also diverged, as Value enjoyed big upgrades while Growth suffered from drastic downgrades.

  • US Value continues to trade at abnormally cheap levels relative to history, US Growth, and the market (gauged by S&P 500). This supports our belief that US Value has room to re-rate higher, backed by fundamentals and a supportive macro backdrop.

  • The US Value composition also provides a good blend of i) cheap, defensive companies from sectors like healthcare, consumer staples, and utilities; as well as ii) exposure to potential sectoral winners, supported by thematic shifts like high-for-longer rates, energy shortages, and de-globalisation. 

  • Aside from the macro setup, fundamentals and valuations continue to support the performance of US Value entering 2023. US Value remains our preferred approach for exposure to US equities. We recommend the JPMorgan Funds - US Value A (acc) USD.

After a decade of underperformance, Value is the underdog no more. The tide has turned, with Value starting to outperform Growth in late-2021 (Chart 1). In the US equity market, this outperformance was the most prominent. US Value shrugged off the market turmoil, falling by a mere -7% in 2022, while US Growth was smashed, falling by more than -30%.

In this article, beyond the macro factors, we show why fundamentals and valuations remain supportive of US Value performance. Additionally, we highlight why we like the underlying US Value composition, which we find to also provide a good blend of cheap, defensive companies and exposure to potential sectoral winners.

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Chart 1: After a decade of underperformance, Value is the underdog no more

 

Support from earnings fundamentals and relative earnings strength 


Fundamentally, earnings growth and estimates continue to support and justify the outperformance of US Value relative to Growth. The aggregate earnings growth for US Value stocks has outpaced Growth stocks yet again in 2022 (Chart 2). Earnings for the MSCI US Value Index grew by 15% last year, after a notable 37% rebound in 2021, surpassing the MSCI US Growth Index’s 3% growth in the same year. 

The shift in the macro backdrop – from low inflation and near-zero policy rates to high inflation and decade-high policy rates – has greatly bolstered earnings of the key sector overweight in the US Value composition. This is likely to continue in 2023, where earnings for US Value are expected to contract by -4% and Growth by -6%. 

Financials, which make up a near-quarter of the US Value composition but only 3-4% of the US Growth composition, is one such example (Chart 3). The sector saw a jump in profits as the spike in rates bolstered net interest margins, while the economic recovery post-Covid spurred loan growth. Energy and materials, which make up 12-13% of the US Value composition but only 2-3% of the US Growth composition, is another noteworthy example. Both sectors experienced significant earnings rebound over the last 1-2 years as the surge in commodity prices above many companies’ breakeven price uplifted revenue growth. Commodity-related sectors may continue to experience decent earnings as we expect commodity prices to remain supported in 2023.

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Chart 2: Corporate earnings growth for US Value has been strong over the past few years 

 

Chart 3: The US Value and Growth composition is vastly different


Earnings estimates have also swung in favour of US Value. The EPS revision momentum has been, and continues to be, largely positive for US Value stocks which enjoyed with a 7% positive revision over the past year. On the contrary, US Growth suffered significant EPS downgrade of -13% negative revision in the same period (Chart 4).

Aside from the heavier weight in financials, materials, and energy, which saw much milder EPS downgrades (the energy sector even experienced EPS upgrades), US Value’s overweight in health care and consumer staples have also contributed to the stronger EPS estimates trajectory. Both defensive sectors had one of the smallest EPS downgrades last year, amongst all US equity sectors. The much smaller exposure to the tech sector, especially the non-profitable growth companies whose EPS were downgraded notably, also helped. The tech sector alone accounts for an outsized 42-44% of the US Growth composition but only 10-12% of the US Value composition. 

Chart 4: Divergence in EPS estimates in FY22. Unlike US Growth, Value saw big EPS upgrades last year

 

Value in US Value


One of the biggest reasons we like US Value is its abnormally cheap valuations. Regardless of the comparison to history, against US Growth, or even the broader S&P 500 index, valuations remain cheap. Relative to history, US Value is trading at a 3% discount to its long-term average as its forward PE has largely compressed in 2022 when equities sold off, while earnings estimates remained resilient, as highlighted above. For comparison, US Growth remains expensive even after last year’s sell-off, trading at a 13% premium to its long-term average. This stark contrast is also a reason why US Value continues to trade at a gapping discount to US Growth. The MSCI US Value index continues to trade at a 41% discount to the MSCI US Growth index, one standard deviation greater the long-term average of 30% (discount). 

We also note that the reversion of relative valuation (ratio of US Value’s forward PE over US Growth’s forward PE) in 2H22 was largely driven by significant valuation compression in Growth stocks rather than a valuation expansion in Value stocks (Chart 5). This leaves room for Value stocks to re-rate which implies further upside. At the same time, valuation headwinds from high inflation and interest rates tend to be milder for value stocks relative to its growth counterpart. As Value-oriented companies tend to generate the bulk of their cash flow in the near future which results in a lower aggregate duration. 

Naturally, US Value trades at a discount to S&P 500 – by a long-term average of 14%. However, this discount has also widened to 21%, suggesting that US Value, which is already a “cheap” expression for US equities, is offering even more value right now. Along with the fact that US Value is still trading attractively relative to its history, we think it is still a good time to add exposure.

Chart 5: US Value continues to trade at a wide discount to Growth, even after last year’s strong outperformance

 

Chart 6: US Value, the already “cheap” expression for US equities, remains much cheaper to the S&P 500 and US Growth as compared to history

 

US Value a blend of cheap, defensive companies with potential sectoral winners


The US Value composition also provides a good blend of cheap, defensive companies, and exposure to potential sectoral winners. These are some attributes we like in the current backdrop. In our view, as a potential recession march closer, cheaper equities (but not value trap) may suggest limited downside risks, while lower entry valuations would also imply greater longer-term upside. At the same time, having exposure to defensive equities can provide additional price and earnings resiliency.  

Traditional defensive sectors such as health care, consumer staples, and utilities make up around 35% of the US Value composition, exceeding the S&P 500 and US Growth’s composition of the same sectors. Our recommended fund, the JPMorgan Funds - US Value A (acc) SGD, further enhances the defensive attribute of a US Value exposure by focusing on high-quality companies. The fund first screens for companies with durable franchises, consistent earnings, and strong management teams. These companies are then screened based on valuation metrics to filter out those with attractive valuations. 

The US Value composition also provides exposure to major ongoing themes such as i) higher-for-longer policy rates (financials – banks, consumer finance, asset management), ii) global energy shortages and commodities security (energy and materials sector), and iii) reshoring and deglobalisation (industrials – manufacturers, logistics).

US Value leadership to continue


We continue to see merits in US Value as performance, relative to US Growth, should be supported by the macro backdrop (outlined in US Value: Value leadership is back – The shield against high inflation and policy rate hike) . Fundamental reasons such as US Value’s earnings strength, valuations, and the appeal of its underlying securities, reaffirms our positive view. 

While we favour US Value for these reasons, we have not completely discarded Growth stocks. For US Growth exposure, we believe it is prudent for investors to remain selective. We prefer high-quality Growth names given the strong balance sheets and earnings resiliency, which we believe can help to weather the recessionary storm. Overall, US Value remains our preferred approach for exposure to US equities, aside from a quality-focused approach. We recommend the JPMorgan Funds - US Value A (acc) USD which offers strong exposure to high-quality Value-oriented companies. 

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