By Rodrigo Campos
NEW YORK (Reuters) - As U.S. stocks hit record highs, some investors are betting the market’s future gains will be increasingly driven by some of its lesser-loved companies.
Value stocks - shares of economically sensitive companies trading at multiples that are usually below those found on growth names - have been among the laggards in the market’s blistering rally from its March lows.
Some investors believe the relative cheapness of value stocks, which include energy companies, banks and industrial conglomerates, will catapult them to leadership if the nascent U.S. economic revival gains momentum, shifting focus from the big technology-related stocks that have led markets during the coronavirus pandemic.
The Russell 1000 Value index trades at almost 18 times earnings, up from 14 a year ago, and is up some 45% since late March. By comparison, the Russell 1000 Growth index trades at a multiple of 31, up from 22, and has gained over 70% in the same period.
"It's an important part of validating the market's rise, to have cyclicals and value sectors move," said Nicholas Colas, co-founder of DataTrek Research.
"At the end of the day I think value can outperform, but it's going to be very episodic."
(Graphic: Russell 1000 Forward P/E ratios - https://graphics.reuters.com/USA-STOCKS/WEEKAHEAD/nmovaqqwwva/chart.png)
Hopes of economic healing got a second wind Thursday, when Federal Reserve Chairman Jerome Powell rolled out a sweeping policy rewrite that puts more focus on fighting unemployment than controlling inflation, sending shares of banks like Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) higher on the day.
Investors in the coming week will be keeping a close eye on Friday’s U.S. non-farm payrolls data, looking for a snapshot of how the country’s economic recovery is faring.
Other arguments for a value resurgence have been fueled by signs of progress on a vaccine against COVID-19, which some investors believe could accelerate business reopenings and a return to in-person schooling across the United States.
U.S. President Donald Trump has said a vaccine for the novel coronavirus could be available before the Nov. 3 presidential election, sooner than most experts anticipate.
Some analysts, including those at Goldman Sachs (NYSE:GS), believe a vaccine could be approved as early as the end of this year.
That could take the S&P 500 as high as 3,700 by year-end and spur a rotation to value names, especially if the news flow regarding a vaccine continues to be encouraging, Goldman’s analysts said earlier this month. The index recently hovered near 3,500.
Plenty of market participants doubt value will return anytime soon, or that such a move can be timed profitably.
Value sectors such as retail have struggled for years with lackluster earnings or business models that are being disrupted in a shift to a more tech-driven world, a process that accelerated during the coronavirus pandemic.
"Valuation alone doesn't drive stock prices. It’s the combination of valuation and improving fundamentals," said Richard Bernstein, chief executive officer and chief investment officer at Richard Bernstein Advisors in New York.
"For value to outperform, one typically needs profit growth to accelerate. That’s not happening yet," he said.
BofA Global Research points out that value stocks have led during the recovery from every one of the last 14 recessions.
Yet it also warns of "value traps" - stocks whose prices are falling faster than earnings are deteriorating. Such stocks have underperformed broader markets by four percentage points a year since 1997, the bank said.
BofA’s model identified energy and brick-and-mortar retail as sectors where value traps can be found.
(Graphic: Performance of Russell 1000 Growth v. Value - https://graphics.reuters.com/USA-STOCKS/WEEKAHEAD/dgkplllxjpb/chart.png)
Kim Forrest, chief investment officer at Bokeh Capital Partners, believes resurgences in value may be a thing of the past.
Technology has transformed the way companies deal with their inventory and altered the business cycle, sapping the benefits cyclical companies would receive from an upswing in growth, she said.
"There are some dinosaurs that don't get that the comet has hit and the (investment) environment has changed," said Forrest.
Others, like Bill Smead of Smead Capital Management, remain hopeful.
An eventual rise in inflation could boost the shares of energy companies, banks and home builders, which have tended to perform better when consumer prices trend higher, Smead said in a note to investors.
Even longtime value bulls like Smead can have their fortitude tested, however.
"We are patient, but that patience doesn’t last forever," he wrote.