Looking for value within value

Value stocks can continue their comeback, but consider higher quality names, says Russ.

Despite daily headlines proclaiming exactly why markets rise or fall, it is always exceedingly difficult to disentangle the myriad of factors that drive stocks. Not only is there no direct way to measure why prices move, but the effort is further complicated by the fact that most of the usual suspects –growth, inflation, interest rates, monetary policy – are correlated. Given recent shifts in the investment regime, this is a particularly difficult challenge today.

Since November several related themes have dominated the markets: a remarkably quick vaccine effort, layer-upon-layer of fiscal stimulus, growing fears of inflation and higher interest rates. Against this backdrop, investors have rotated from secular growth companies to high beta, more cyclical and lower quality value stocks. Going forward I would stick with two of these themes – cyclical and some value – while trimming high beta and lower quality names.

Value yes, beta less so

After being written off as dead, value stocks have staged a comeback in recent months. In the first quarter value dramatically outperformed (see Chart 1).

MSCI World factor index performance – year to date

MSCI World factor index performance – year to date

Source: Refinitiv DataStream, chart by BlackRock Investment Institute, as of April 12, 2021. Past performance is no guarantee of future results.  Index performance is shown for illustrative purposes only.  You cannot invest directly in an index.

The value rally is part payback following years of underperformance and part circumstances, i.e. the best growth in decades.  But while the recent rally has narrowed the gap with growth stocks it has not come close to eliminating it. On a five-year basis growth (MSCI World Growth Index) has still outperformed value (MSCI World Value Index) by somewhere around 70%!

While the value rally continues, it is sputtering in the more speculative corners of the style. A good illustration is the performance of small cap value, a play on both cheap stocks and volatility. During the period from early November through mid-February small cap value (MSCI World Value Index) gained roughly 40%, nearly double the broader market.

However, since mid-March small cap value stocks are down while large cap value continues to advance. There are several factors at work, but one contributor is almost certainly the volatility inherent in small cap names. 30-day volatility on small-cap value is roughly 60% higher than large-cap value. While investors are looking for cyclical exposure, at the margin they are turning more cautious on pure market risk.

Follow the earnings

Given this dynamic I would look to trim the highest volatility names in favor of higher quality issues. Besides quality, another theme to lean into is earnings momentum. Unlike last year when earnings multiples surged, this year’s gains are being driven by earnings growth. Companies witnessing positive analyst earnings revisions are more likely to lead. This supports my recent preference for financials, including U.S. and European banks and consumer finance, mining companies, manufacturing and the more cyclical portions of tech, such as payment companies.

While this bull market is barely a year old, with major averages more than 80% above the 2020 lows we are no longer in the first stage. As the bull market matures chasing volatility may be less rewarding. Instead, focus on cyclical exposure, a reasonable price and an ability to drive earnings growth.

Russ Koesterich, CFA, JD
Russ Koesterich, CFA, JD
Russ Koesterich, CFA, is a portfolio manager for BlackRock’s Global Allocation Fund and lead portfolio manager on the GA Selects model portfolio strategies.

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