Investors who anticipate that now is the time to rotate out of growth stocks and into value stocks should think twice, according to strategists at Sanford C. Bernstein quoted by Bloomberg. Bernstein has cut "crowded" value stocks to a neutral rating, Bloomberg says, quoting a recent research note as being "concerned about sentiment towards value having become too stretched."
Bloomberg reports that a switch to value was popular at the end of 2016. Investors apparently expected outperformance in 2016 to extend into 2017: the MSCI World Value Index returned 13.23% in 2016, versus 8.15% for the MSCI World Index, per MSCI. In 2017, for the year-to-date through November 30, the return for MSCI World Value has trailed MSCI World, 16.25% to 21.39%, also per MSCI.
Recent Value Leaders
The MSCI Value Index included 878 large cap and mid cap stocks from 23 developed markets as of November 30. The three selection criteria are book value to price ratio, 12-month forward P/E ratio, and dividend yield. Among the top 10 constituents, six recently have outperformed the S&P 500 Index (SPX), which was up 2.8% from the close on November 14 through the close on December 14.
These stocks, with their price appreciation during the same period are:
All members of the top 10, as well as 59% of the index overall, are U.S.-based companies.
In the five days up to December 4, "cheap U.S. stocks beat those with faster earnings growth by 3.7 percentage points, the most in such a period since the 2007-09 recession ended in the summer of 2009," The Wall Street Journal reported on December 7, calling this a "phenomenal" rotation.
Indeed, much of the recent gains registered by the individual value stocks listed above were made in this narrower time frame. The Journal also cited research indicating that "value stocks beat pricey stocks by the most since 2009 within sectors."
Moreover, the Journal concluded that this rotation was driven by more than just the improving prospects for a cut in the federal corporate income tax rate. If that were true, most stocks in high-tax sectors should have risen. Instead, the Journal notes, value stocks generally rose across the board, whether in high tax or low tax sectors.
However, while the Journal cites traditional retail as a prime example of a sector that investors have "given up on" due to "disruption from new technology," a recent surge in retail stock prices indicates quite the contrary, at least temporarily. (For more, see also: 5 Retail Stocks That May Ruin Your New Year.)
Positives For Value
Going forward, the Journal indicates that faster economic growth, higher inflation and, most crucially, higher interest rates would be positive for value compared to growth. The main reason: growth companies, especially those in tech, tend to have expected profits way off into the future. Higher interest rates mean higher discount rates for those far-off earnings, making them less valuable in today's money. By contrast, value stocks tend to be generating profits, and paying dividends, in the here and now.
Part of Bernstein's case against value stocks is that they expect reflation to happen slowly, per Bloomberg. Meanwhile, earlier this month, strategists at JPMorgan Chase saw the improved prospects for tax reform as a cause in itself for a rotation out of growth and into value, CNBC reported on December 4.