Source: Bloomberg, 18 August 2023
Japan, long seen as one of the great value traps, has been a standout performer for the style. We have seen an increasing awareness and action by Japanese companies to improve corporate governance and shareholder returns for some time. In addition to that, an announcement in February by the Tokyo Stock Exchange encouraging companies (especially those trading at less than 1x price to book) to increase their focus on sustainably improving returns has provided even more impetus for the pace of change to accelerate. The fact that roughly half the Japanese market is currently trading below the 1x price to book threshold hasn’t been lost on global investors.
Although Japan has been a standout performer for Value, it has been well supported by other regions. Whilst the sharp rise in the cost of capital experienced during 2022 provided the catalyst for Value’s turnaround, in our view this turnaround has also been supported by a number of other drivers, some of which were either emerging or have accelerated since the pandemic.
Whether it be the acceleration of the global energy transition driven by US incentives, Russia’s war on Ukraine, China’s attempts to re-structure its property market or the uneven exit of economies from the COVID pandemic, these factors are helping to drive a change in the relative attractiveness of many stocks.
Whereas for much of the past decade we have seen a high level of singularity in the drivers of performance across and within global equity markets, today we see multiple dislocations. We believe this is creating a broader base of opportunities from which to generate alpha, and therefore helping to level the playing field for active Value investors in trying to offset the outsized performance from a concentrated number of mega-cap Growth stocks.
Will the impending recession derail Value?
As interest rates continued to fall for much of the last decade, supported by a narrative of secular stagnation, investors’ perception of risk also changed relative to prior periods.
As a result, stocks perceived as either ‘Value’ or ‘high risk’ saw a change in their patterns of performance, exhibiting much larger drawdowns in periods of economic weakness, followed by stronger performance in periods of economic recovery.
Value has many defensive areas that historically have provided a buffer to cyclical Value stocks during periods of economic weakness. However, over the past decade this dynamic has not been strong enough to offset the performance of long duration Growth stocks, which have been supported by ever lower interest rates.
The normalisation of interest rates that has occurred over the past year, back to levels not seen for the last decade (and at a time when valuation dispersions remain at or close to historical highs) provides, in our opinion, the potential for the natural diversification that exists within Value to play a more dominant role.
Whilst we could argue that many cyclical Value stocks are already priced for a recession, we see the opportunity for defensive Value stocks to act not just as a natural hedge from any cyclical weakness, but also as a source of diversification should interest rates remain at more normalised levels, and we see valuation compression.