It’s time to get picky with value stocks.
The best days of the value-stock rotation are behind us, argues Evercore ISI equity strategist Dennis DeBusschere, and investors should be cherry-picking individual names instead of betting on the whole group.
The market’s cheapest stocks have staged a comeback against growth stocks over the past two months, and there has been much talk about a sustained rally in the group. Since Sept. 1, the
iShares S&P 500 Value
exchange-traded fund (ticker: IVE) has increased by 9.6%, while the
iShares S&P 500 Growth
ETF (IVW) rose only 4.6%.
We’ve seen two extended value rallies over the past decade, but both had been supported by unusual catalysts: the China stimulus in 2013 and the surprise Donald Trump victory in 2016. For the current rally, however, DeBusschere sees scant evidence that global economic growth will improve as much as it did in 2013 and 2016.
To be sure, the Federal Reserve has cut rates three times this year, and investors are still generally optimistic that the U.S. and China will close in on a partial trade deal. All three major U.S. stock indexes hit record highs over the past week on the positive sentiment, and the flat yield curve—a recession signal—has eased. But news reports suggest the trade deal still has many more complications and roadblocks, and now the Hong Kong protests have become another thorn between the two countries.
Instead of signaling long-term confidence in growth, DeBusschere thinks the recent movement in the bond market is more likely driven by hedge funds’ unwinding of previous positions against deflation as trade tensions have de-escalated. With no true positive catalysts in the near term, he argues that the value rally will start to wane.
Still, that doesn’t mean there’s no opportunity for value investors at all. For the past two months, the movement of different types of value stocks was driven largely by the bond market, and that has left portfolio managers with little leeway to add incremental value to their portfolio.
But recently, the correlation among stocks and different factor groups in the U.S. market have fallen to a low level, noted Bernstein strategist Inigo Fraser-Jenkins, who writes: “This suggests that portfolio managers can form portfolios where single stock risk is the dominant driver of the portfolio.”
Stock-picking within the value space should become more important going forward, and earnings outlooks will likely be the key performance driver.
Value stocks in general have weaker expected earnings growth, but their numbers are improving. The relative earnings downgrades for value stocks versus those for other stocks appeared to be reaching a bottom just before the recent earnings season and have since recovered, noted Fraser-Jenkins. “There are signs that support for Value can come from what is already a very low expectation for earnings, which should shield them from further downgrades,” he wrote.
Fraser-Jenkins recommends a list of “value stocks with a catalyst” for the U.S. and European market. The basket includes stocks that appear cheap relative to the market, but also showed strong earnings momentum and positive views—or at least not negative ones—from Bernstein analysts.
The basket contains stocks from the health-care, industrial, tobacco, and materials industries, including
British American Tobacco
Hewlett Packard Enterprise
Delta Air Lines
(DAL), United Airlines Holdings (UAL), Rio Tinto (RIO),
DuPont de Nemours
Some of the stocks here are not traditionally considered value names, such as Apple and DuPont, which both trade at almost 18 times forward earnings. But Fraser-Jenkins noted that these companies still appear mispriced given their level of profitability as compared to sector peers, so there is still room for them to grow.
Write to Evie Liu at firstname.lastname@example.org