September 2020 marked what could be one of the most significant changes in the stock market for the past 12 years: value stocks started to outperform growth stocks. Importantly, this rotation could go on for a long time to come, offering opportunities for substantial gains.
What is meant by ‘growth’ and ‘value’ stocks?
Growth companies are those whose earnings can grow independently of the broader economy, the classic example being tech companies, or some health care stocks. Value companies are those whose earnings go up and down with the economic cycle, thus they are also called ‘cyclical’ stocks.
Since the GFC ended, value stocks have underperformed growth by the greatest margin ever. Why did that happen?
Cyclical stocks are dependent on what you might call ‘organic’ GDP growth. On one side of the economy, the GFC caused a massive slowdown in private sector growth as companies tried to get their balance sheets back in order by reducing borrowing, and on the other side, governments all over the world tried to reduce their spending to avoid blowing out national debt levels, a policy also known as austerity.
The consequence was the post-GFC economic recovery was the slowest and weakest on record, so it followed that cyclical companies’ earnings growth was also weak. Naturally, investors backed growth companies instead.
Why are value stocks back in favour?
Governments around the world have responded to the COVID crisis with massive amounts of fiscal support, which has ignited organic economic growth. Here in Australia the federal government has injected the equivalent of 13 per cent of GDP in brand new money, plus another 2 per cent came from early superannuation withdrawals. In the US it’s been a mind boggling 25 per cent, and even Europe has joined in.
The upshot is, after most economies reported record falls in GDP in June of last year, we’ve seen a sharp reversal. Australia recorded back to back quarterly GDP growth above 3 per cent for the first time in the 60 year history of the National Accounts. And in the US, Goldman Sachs is forecasting 2021 will see 8 per cent growth for the first time in 70 years.
As usual, the share market has anticipated the reversal of economic fortunes and value stocks have already enjoyed a sizeable rally. From its bottom last year, the Australian bank sector has bounced 39 per cent, energy by 34 per cent (after oil famously traded below zero last year) and materials 17 per cent.
Why value stocks could rally for a while yet
While they are sizeable moves already, it’s possible the rotation toward value stocks will continue for some time yet. The sheer size of the government stimulus packages saw the Australian household savings rate peak at 20 per cent, and it’s still at 12 per cent, which represents a lot of potential spending still to come. In the US, households are estimated to be sitting on more than US$1.6 trillion in savings, or about 9 per cent of GDP.
Another reason is shown in the chart. In the 12 years since the GFC global value stocks gave up almost 30 years of outperformance against growth stocks and appear to have only just started to claw some of that back. There have been other attempts to turn the tide that were short lived, but none have been backed by such a compelling change in macro support. Indeed, Richard Bernstein of Bernstein Advisors, formerly the Chief Investment Strategist at Merrill Lynch and one of only 57 inductees to Institutional Investor magazine’s Hall of Fame, said “the difference in performance (between value and growth stocks) could be startling to investors over the next couple of years”.
How to position your portfolio
There are plenty of value-oriented fund managers you can invest with, like Perpetual and Platinum. I’ve also written previously that I think the resources sector faces a strong outlook. There are unlisted managed funds that specialise in that area, like Ausbil’s Global Resources Fund, or a listed one is the Tribeca Global Natural Resources LIC (TGF.ASX). BetaShares has an Australian resources ETF, but 53 per cent is invested in BHP, RIO and Fortescue, so it’s heavily influenced by the iron ore price.
For global exposure, VanEck’s new VLUE ETF uses a proprietary ‘Value Enhanced’ algorithm to invest in a basket of 250 value stocks from across the developed markets ex-Australia. And finally, Europe, the UK and Japan also offer a value-oriented bias.
Call us today if you’d like to discuss how to gain exposure to value stocks in your portfolio.