What's up with value?
Q: What’s behind the recent down-and-up performance by value stocks? Value companies, particularly cyclical value companies, are tied more directly to the direction of the overall economy relative to growth companies, which are essentially creating their own growth through innovation and disruption. As such, the relative underperformance of value cyclicals during the earlier stages of the pandemic was unsurprising, given the sudden onset of a severe, though likely short, recession. Similarly, as the market has shifted its attention from recession to recovery, the outperformance of value since mid-May should be viewed as logical. We think weakness in the more defensive/income-based names has been a reflection of impaired cash flows and the perceived risk to dividend payments. As the recovery gets underway, we would expect those companies that have been able to defend/expand their dividends to be rewarded by the market.
Q: Do you think there has been a structural shift in the market environment, which has led to sustained divergence in the value vs. growth style factors? Longer-term, we think there has been a shift. Historically, global growth has been abundant, given robust population growth, innovation and an arising middle class in the emerging world. Thus value had a premium. Now, with half of the world’s GDP in regions that are experiencing sustained, peace-time population decline, growth no longer is abundant. This has benefitted the U.S., which enjoys both population and innovation growth, and in particular U.S. growth sectors. Additionally, given their more asset-light business models, growth companies have enjoyed tremendous cash flow, which has made this area of the market more defensive than it had been traditionally.
Q: Given the rapid and steep sell-off and subsequent surprisingly strong bounce, what’s your view on current and historical valuations? Even with the tremendous recovery off March’s bear-market lows, areas of cyclical value remain attractive from a valuation perspective. Our view is that companies that have the cash flow, balance-sheet strength and business models to survive may enjoy meaningful appreciation that would bring valuations in line with historical averages as the economy transitions from contraction to expansion. We think, however, that security selection is of paramount importance as some of the weaker players in value sectors are unlikely to recover or survive. As for growth, its emergent defensive characteristics, strong cash flows, share gains and disruptive business models warrant potentially higher P/E multiples going forward.
Q: What’s your outlook on value investing in this low-rate, recessionary environment? Our view is the Stay-At-Home Recession of 2020 encompassed the first and second quarters of the year, with a recovery likely in the second half. Given that, we think the worst is over for the value sectors and would expect some catch-up in the short-to-medium term. Again, our view is that security selection will be key, as the dispersion between winners and losers is likely to be greater going forward than it has been over the past several years. Similarly, for the dividend names, the last decade has been one of expansion and low rates. This has made it easier to defend and increase dividends, and made dividends more attractive relatively to historically low bond yields. In coming months, there could more risk to cash flows/ability to pay among some dividend payers given the economy, while reopening, is far from operating at capacity. But government bond yields that are likely to remain very low for a long time are only adding to the relative attraction of dividends—the dividend yield of the S&P 500 is nearly double that of the 10-year Treasury yield, and among the true dividend payers, the advantage is even greater.