A recent article in Advisor Perspectives suggests that the “potential return opportunity in a value-oriented equity strategy might be much larger than normal today” for the following three reasons:
- Long-term premium on value strategies compensates investors for disaster risk: If the worst of the Covid-19 pandemic is behind us, “history would suggest the potential for a large payoff on value strategies,” the article argues, adding, “In the United States, value stocks have, on average, outperformed by 730 basis points in the 12 months following a trough in the business cycle.”
- Value stocks have more balance sheet leverage than the broader equity market, suggesting that “relative performance of these businesses is still likely to hinge on movements in credit spreads.” The Fed’s efforts to support the corporate bond market could result in compression of high-yield credit spreads over the next 12 months. The article notes, “Our research suggests that value stocks, on average, have outperformed by 1,600 basis points in periods of falling credit spreads.”
- Value stocks have a shorter duration profile to their cash flows than growth companies, “where analysts must discount large anticipated earnings streams far off in the future.” As a result, value companies tend to show equity performance patterns that are sensitive to movements in the U.S. Treasury yield curve. The article predicts a widening yield curve going forward and cites research showing that during 12-month periods when this occurs, value stocks on average outperform by 330 basis points.
The article concludes: “While we don’t have a crystal ball on what exactly the future may hold, the extreme discount in value stocks today, coupled with the potential for positive cyclical catalysts, suggests that investors should hold the line on their strategic factor investments in value companies.”