A value rotation with legs

8 min watch 15 Apr 21

After a bumpy start to March, market sentiment improved as investors began to focus on post-lockdown opportunities amid successful vaccine rollouts, better economic data and another announced round US fiscal stimulus. Associate Investment Director, Kirsty Clark reviews market performance over the month, discusses the prospects for value stocks as we move through 2021, and reveals how active management can play a role in helping investors take advantage of emerging opportunities. 

Global equities limped into March after a turbulent February when investors worried that central banks may have to act sooner than expected to quell inflationary pressures. However, sentiment began to improve as vaccine rollouts continued apace and markets focused on post-lockdown opportunities. 

Upward revisions to economic data, positive consumer confidence indicators and a further stimulus boost following US President Biden’s announced $2.25 trillion fiscal package, supported developed market equities in particular. The MSCI AC World Index finished the month up 2.7% in US dollar terms.

European and US equities outperformed. Germany’s DAX 30 led the gains while the S&P500 Index in the US crossed the 4000 mark for the first time as investors’ focus shifted to reopening prospects. In the UK, small-cap stocks were the strongest performers. Asia ex Japan and Emerging Markets were the relative laggards, finishing down over the month – although Latin America performed well, helped by positive returns in Mexico, Chile and Brazil. In terms of style, the continued market rotation saw value outperform growth in March. However, growth outperformed in the final few days of the month, for the first time since January. 

In fixed income, US, German and Italian 10-year government bonds remained under pressure, with the yield on the US 10-year treasury hovering around 1.7% at the end of March. The US dollar strengthened against a basket of currencies.

In commodities, Brent crude finished the month down as rising coronavirus cases in a number of European countries, and further lockdowns, sparked fears of a delay to the global reopening. However, it is still among the strongest performers year to date, up around 23% through the end of March. Gold remains a casualty of the market volatility this year, losing ground in March and down around 10% since the beginning of the year. 

All sectors gained ground over the month, with more traditionally defensive areas such utilities and consumer staples leading markets higher. Alongside rising bond yields, we also saw a continued rotation into cyclicals and value stocks, which supported industrials, materials and financials, but weighed on more richly-valued growth names. The MSCI AC World Growth Index just managed to secure positive gains in March. 

Technology, telecom and consumer discretionary also lagged the wider market over the month. A number of US and Chinese tech and media stocks were caught up in large block trades at the end of March after family office Archegos Capital was forced to unwind equity derivative positions amounting to more than US$20 billion. Investment banks including Nomura and Credit Suisse were also left nursing large losses in their prime brokerage divisions.  

Last month marked one year since the COVID-induced market lows on 23 March 2020. Since then, global equities have risen by over 80%.

While there remains some nervousness around the risk of ‘runaway inflation’, amid rising bond yields, many investors are shifting their focus to take advantage of the reflation trade and attractive value opportunities. 

The value rotation in equity markets is also reflected in recent asset flows – with predominantly global and developed market value funds receiving net inflows in March, following four consecutive years of net outflows.

In our view, the combined tailwinds of ongoing loose monetary policy, large-scale fiscal stimulus, higher bond yields and rising inflation expectations, and a sooner-than-expected return to growth, all provide a supportive backdrop for value stocks. 

We started to see the green shoots of the value rotation back in September last year, and a more pronounced rotation from early November following developments in effective COVID-19 vaccines. This year, we’ve started to see a broadening of market performance with accelerated regional vaccine rollouts changing expectations of the speed of reopening, and subsequent demand growth and earnings recovery.

Despite recent strong performance, value still remains at depressed levels when compared with growth. In both the US and Europe, the spread between the cheapest and most expensive stocks on a price-to-book basis remains at historical highs. The most richly-valued stocks are trading at the largest valuation premium to the least expensive names since the ‘tech’ bubble over two decades ago  – which suggests to us that the market rotation has further to run from here.

With signs of the market dynamics we’ve witnessed since the Global Financial Crisis beginning to unravel, we think there are emerging opportunities for value investors across a broad range of sectors. Value typically outperforms in the early stage of an economic recovery, but we believe the extreme valuation gap between growth and value stocks, along with indications of a reversal of the ‘lower for longer’ rate environment, provide additional tailwinds for a more sustained value recovery. 

However, there is still the potential for negative surprises and an ‘uneven’ lifting of lockdowns, so the route back to growth may not follow a linear path. We could see investors’ convictions waver and risk appetite fluctuate in response to near-term newsflow. In addition, with the adoption of new technologies and behaviours, the shape of the post-COVID global economy may differ from the pre-lockdown ‘business as usual’. 

In seeking value opportunities, it will be vital for investors to identify which companies are best positioned to take advantage of emerging themes and structural opportunities, and be able to distinguish ‘misunderstood’ value stocks from ‘cheap for a reason’ companies. This is where active management can come to the fore, and we have seen active equity funds globally attracting $80 billion of net inflows year to date – the last time this happened was in 20131.

Being nimble and adopting a selective, fundamentals-driven approach to value investing allows the flexibility to take advantage of new opportunities, but also the scrutiny to avoid the pitfalls and to mitigate the risk of permanent loss of capital. Strong stock selection will be increasingly important as we move through 2021 to sort the wheat from the chaff.

1Citi Research, EPFR, 22 March 2021

By Kirsty Clark

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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