A strategy that bets on U.S. equities that look undervalued and against expensive ones is rising again on Tuesday after posting its biggest rally in two months on Monday. The Nasdaq 100 fell as much as 2% at the open, compared with a 1.1% drop for the Dow Jones Industrial Average.
“Renewed value leadership at the factor level and the broader risk-on rebound suggest the economic cycle is continuing rather than peaking,” Evercore ISI strategists led by Dennis Debusschere wrote in a note.
The Russell 1000 Value Index has jumped more than 1.3% this month while the Nasdaq has lost money. It’s all shaking up the world of exchange-traded funds, where assets in value ETFs have firmly overtaken those of funds tracking the growth investing style, according to smart-beta data compiled by Bloomberg Intelligence.
All this means quant investors who stuck with value during its historic pounding in the pandemic are getting their mojo back, while traders crowding into speculative tech-heavy corners of the market including Cathie Wood’s ARK funds are on the back foot.
It’s a comeback long in the making. Value shares — or those with low prices relative to some fundamental indicator like earnings — are typically more dependent on the business cycle than tech stars like Tesla Inc. They have been persistent laggards in recent years, especially when last year’s lockdowns drove investors further into stay-at-home names like Zoom Video Communications Inc.
But while most value revivals have proved fleeting in the post-crisis bull years, a slew of analysts now say the stars are aligned for this one to last.
Higher inflation expectations have tended to favor value, since it typically comes with faster economic growth and higher bond yields, hurting tech stocks whose long-term prospects now have to be discounted at higher rates.
Over the past month, the energy, materials and financial sectors have led the S&P 500. Tech has been the worst performer.
Even former skeptics predict this rotation has further to go. Sanford C. Bernstein strategists, who once joked about value managers having no clients, said in a note on Friday “there is plenty of ammunition left.”
“Value stocks remain the most uncrowded part of the market,” the team wrote in a note. “In the longer run, this rotation is but a blip in the persistent underperformance of value versus growth.”
Because of value’s historic drawdown last year, its recent recovery has only narrowed its discount slightly, with the spread still at double the 10-year average and triple the 20-year. At Barclays Plc, strategists led by Emmanuel Cau noted value sectors like mining and financials might even be getting relatively cheaper, since their earnings — the denominator of those multiples — are rising faster than prices.
At Versor Investments, which is among the quant funds that predicted a value comeback, founders Deepak Gurnani and Ludger Hentschel pointed out that after the dot-com bubble burst, the strategy posted strong performance between 2000 and 2004.
“The positive value returns in 2021, so far, have done little to shrink the extreme value spreads created by the previous negative returns,” they wrote in a report.
Meanwhile, the market shift means that investors in momentum — an allocation style that buys recent top performers — have been putting more money into value, after bidding up tech names in recent years. The semi-annual rebalancing of the $14 billion iShares MSCI USA Momentum Factor ETF (ticker MTUM), for instance, is expected to see a big rotation into cyclical and riskier names this month.
At least one large cohort of money managers has yet to join the rally. Bank of America Corp. noted last week that the value rotation has yet to exert much influence on the returns posted by active funds. That suggests these investors may be braced for pain if instead they chased the likes of Big Tech and renewable energy at the market top.
“Portfolios are still majorly composed of long duration growth assets and hence would be prone to losses if macro/inflation dynamics continue to improve,” strategists at Barclays wrote. “Cheap, economically sensitive, and an inflation hedge, value seems like the natural place to position a portfolio.”