Think you’ve missed the value boat? Think again

Jul 26th, 2021 | By | Category: Equities

By Anthony Beevers, Portfolio Manager at First Trust Global Portfolios.

Think you've missed the value rally? Think again

Think you’ve missed the value boat? Think again

Value rallies within a historical context

The Covid-19 vaccine announcement on 9 November 2020 triggered a significant factor rotation in favour of value. Looking back through time, our research shows that this current rally (eight months and counting) is dwarfed by some historical rallies, going back to 1929.

Remarkably, in the US at least, there have been a total of 11 value rallies (including this one). On average these rallies have lasted 78 months with an average performance of 73% over that period. However, there have been some significant outliers with the longest rally continuing for almost 40 years (470 months). What’s interesting is that this also contains the last major inflationary period (1965 – 1980). Some food for thought.

Missed the value boat?

Until recently, many value investors had struggled to see light at the end of the tunnel, with 2016 the last time value (Price/Book) appeared on top of the annual factor charts. As we saw worldwide, growth stocks were the main driver of stock market performance, leading many to call the “end of value investing.” Even then, many were unaware of value’s outperformance between 2011 and 2016, which was uncovered by our aforementioned research.

Looking at the last 12 months (April 2020 to April 2021), the value factor has surged by 86.9% while the S&P 500 Value Index returned 50.4%. For context, the S&P 500 Index was up 56.4% over that same period, while the dividend yield factor increased 71.3%. Also, and potentially unexpectedly, the “work-from-home” related CTA Cloud Computing Index advanced 76.6%, a reminder that growth can still produce positive returns when value is in favour.

Evidently, this performance dispersion between the “Value Factor” and the “Value Index” (S&P 500 Value) suggests the latter hasn’t captured the value premium effectively. We believe this highlights that investors can be misled by labels.

Naturally, given the rally that value has recently enjoyed, many will be wondering if they might have missed the boat. There is a common misconception that value rallies are short and steep. Firstly, recall how long value rallies can last. Further, we believe that despite this recent rebound, value remains relatively “cheap”, at least on a historical basis – almost as cheap as prior to the vaccine announcement.

Value dispersion, then and now

Source: First Trust Global Portfolios.

Our research team has also devised a value dispersion tool, with data going back to the early 2000s and the dot-com bubble. Our tool highlights how widely dispersed the value of stocks are (i.e. how cheap are the cheapest stocks – using P/E and P/CF metrics, etc. – relative to the most expensive). For context, the highest ever recorded over the last 21 years of data was 11.13. As a frame of reference, the relative cheapness of US equities in October 2020 was 9.66 (just before the current Value rally). The dispersion now sits at 8.61, still extremely high on a historical basis.

Currently, this dispersion sits comfortably inside the top 25% of our historical values, i.e. still relatively cheap, which perhaps is a positive indication that this rally has some way to go.

Some pitfalls of value investing

As we mentioned earlier, investors need to be mindful that their investments effectively deliver the returns they’re looking for; illustrated perfectly with our crude comparison of the “value factor” and the “value index.” Investors should be mindful of how their portfolios are constructed to effectively capture the value premium, whilst diversifying away as much risk as possible. In contrast to some of the most famous growth cycles which can be driven by a narrow set of stocks, value rallies typically are led by a multitude of different stocks across various sectors. Investors should be aware that with value, in particular, holding the same companies for long periods can make your portfolio more vulnerable to a rollover once those stocks reach their more “fair value.” Keep in mind that over time the cheapest stocks will change and a given stock typically isn’t both always cheap and delivering positive returns. Therefore, we believe that investors require a robust sell discipline, to ensure that stocks are sold as they recover their value.

Pairing value & the importance of a sell discipline


First Trust US Equity Income UCITS ETF

–  Offers investors exposure to US value and
income factors by tracking the NASDAQ US
High Equity Income Index.

– Launched in April 2016 on London Stock
Exchange under the ticker UINC LN.

– Houses $150m AUM; comes with an expense
ratio of 0.55%.

At First Trust, we prefer a rules-based approach; pairing value with either an income approach or with momentum stocks. Generally, rules-based approaches enable action in the face of fear, uncertainty, and exuberance.

With value and income factors, structurally they represent similar concepts, e.g. sorting stocks by their dividend yield is one approach to determining if they are valued cheaply or expensively.

Also, history tells us that these two factors may move in tandem, as evidenced over the last 12 months (every month in 2020 – aside from one). This helps the investor get paid to wait for their stocks to appreciate. The rebalancing process can help to allocate the portfolio to stocks that are, on average, higher-yielding and cheaper than their peers.

Further, investors should be aware that valuations can snap back very quickly; thus, stocks should be constantly anchored and evaluated to ensure they remain “cheap”. We believe a sell discipline can enable investors to continue to capture the positive returns of a value rally by ensuring stocks are sold once they recover their value and replaced with companies with the potential to outperform. Our belief is that we’re still at the beginning of this value rally, and the value ship hasn’t sailed yet.

Source: First Trust Global Portfolios.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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