- Nowadays, US value trades at its steepest discount to growth since 1999. However, declining Covid-19 cases, a broad-based economic recovery, prospects of higher interest rates as we progress out of the pandemic, and the return of persistent inflation pressures should help close the valuation gap between growth and value stocks.
- The economic and financial environment is shifting in favour of value over growth. In particular, investors should avoid hyper-growth stocks with high price-to-earnings ratios, as higher interest rates mean a higher discount rate, which lowers the net present value of future cash flows for those growth names.
- Conversely, in our view, investors will have a second chance to exploit opportunities in the value space. We believe that these will lay less in the cyclical component of value stocks – as was the case in the first wave of the value rebound – and more in energy and financials, which should benefit from higher inflation, the upward trend for commodity prices, and a rising interest rate environment.
- There are ample ESG-friendly investment opportunities among value names. The United States currently lags other countries in adopting ESG practices. However, there is evidence that US firms are closing this gap and offer appealing opportunities to invest in value companies with an ESG-improvement trajectory.
In our Investment Talks published in October 2020, we made the case for value stocks to outperform their growth counterparts based on two key reasons:
- Value was trading at a much larger-than-normal discount on forward price-to-earnings than growth.
- Unprecedented fiscal and monetary stimulus was likely to reflate the US economy, favouring value stocks given their cyclical sensitivity.
Over the period from 31 August 2020 to 30 September 2021, value has outperformed growth. The Russell 1000 Value Index (Value index) gained 28.9% versus a 19.5% gain for the Russell 1000 Growth Index (Growth index). However, between May and August 2021, growth outperformed value, as Covid-19 cases surged across the United States due to the spread of the Delta variant. Generally, during the pandemic, growth stocks have outperformed when Covid-19 concerns have risen as many of these stocks are technology-related and benefit from a stay-at-home environment.