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Is value back in fashion?

04 October 2019

5 minute read

By Julien Lafargue, CFA, London UK, Head of Equity Strategy

After years of underperformance, value stocks rebounded significantly in September. But how long will this rotation to value and away from quality stocks last?

A lot has been written about the underperformance of “value” as an investment style. “Cheap” stocks have been out of favour for most of the last decade, creating an unprecedented performance gap compared with their “quality” peers.  Most recently, value started to outperform, prompting investors to wonder if value had finally come back in vogue? We think it hasn't.

Definitions matter

Before explaining why we believe quality stocks are best positioned in the current environment, a caveat is required. There is not a unique definition for value, “growth”, “momentum”, quality or any other broad-based investment style. As such, we normally refrain from discussing - let alone recommending - style-based investments unless they have been clearly defined beforehand.

With regards to our preference for quality, as highlighted in the May edition of Market Perspectives, we focus specifically on a company’s ability to generate cash.

Value needs economic momentum

We see two main reasons why value, as defined by some of the most popular indices and exchange traded funds providers, is unlikely to outperform over the medium term.

First, value tends to produce higher returns than the overall market in periods of strong economic growth. This was the case in 1988, 2000 or between 2004 and 2006, when world gross domestic product grew by more than 4%.

The main factor explaining the above correlation is that value is often found in some of the most cyclical parts of the markets, such as banks or car manufacturers. Given limited room for further monetary stimulus and an economic cycle that is almost 10 years old, we don’t anticipate growth to re-accelerate meaningfully. This should prevent value stocks from outperforming.

Timing is key

Outside of periods of a sustained economic boom, value’s outperformance tends to be relatively short-lived. This is not surprising as efficient markets are generally quick to reassess mispriced assets. In order to benefit from any short-term value opportunity, investors must time their investment with great precision. The rotation to value we saw in September lasted no more than a week and is unlikely to come back unless macroeconomic leading indicators start showing signs of improvement.

Passive investing eroding value

Away from these cyclical considerations, investor behaviour is another reason why we believe that value is unlikely to outperform over the medium term.

The increasing popularity of passive and factor-based quantitative investing strategies may have eroded the premium investors would normally receive by investing in cheap stocks. In other words, the amount of real value available is lower than it used to be because large pools of money are, by design or default, already supporting share prices.

Value linked to “has-been” industries

Furthermore, value is typically found in old industries. Not only do these face significant challenges to their business models, for instance traditional banks and app-based neobanks or car manufacturers and new mobility solutions, they are also largely unappealing to the new generation of investors.

Familiarity bias will likely continue to push market participants towards companies and stocks they know, understand and possibly use on a regular basis. This should support innovative, technology-based (and growth-oriented) companies to the detriment of their value peers.

Quality stocks increasingly outperform

Stick to quality

Quality still seems the most compelling investment style for the medium-term investor. Sure, value like any other factor may have bursts of outperformance, but these are difficult to capture. More importantly, whether one invests in quality or value, we believe that factor investing should make use of active management to better capture the opportunities offered.

Quality still seems the most compelling investment style for the medium-term investor.

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Market Perspectives October 2019

Barclays Private Bank investment experts highlight our key investment themes. They show how security selection and a bias to quality companies can provide the yield and outperformance needed at a time when it may be tougher to produce positive returns.

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