In the past few years, growth stocks have outperformed value stocks, but value stocks’ fortunes are starting to turn.
U.S. large-capitalization value stocks are up 8.5 percent this year versus U.S. large-cap growth, which is up 3.4 percent this year. Similar trends are seen in mid-cap and small-cap sectors. It’s possible that value’s current outperformance versus growth is simply a rebalancing, but with the Standard & Poor’s 500 index near all time highs, some investors may be willing to seek out value stocks as they seek bargains.
Crit Thomas, global market strategist at Touchstone Investments in Cincinnati, says growth and value stocks generally trade off each other, meaning one will lead while the other lags, with most cycles lasting about seven years. Currently, growth stocks have led for about 10 years, which is the longest either growth or value has outperformed, he says, making growth-stock valuations rich.
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“If I look at relative price-to-book (valuation), growth is looking very expensive relative to value. We’re at a level we haven’t seen since the dot-com boom,” he says. “If you look at the index, the S&P 500 is looking much more top heavy from a growth standpoint, which is what you would expect, given growth has been (outperforming) for so long.”
Larry Pitkowsky and Keith Trauner, co-founders of GoodHaven Capital Management in Milburn, New Jersey, agree that growth-oriented stock valuations are rivaling the peak of the Nasdaq-led technology boom of 2000.
“At the apex of the tech boom it was difficult” for managers who picked valued-oriented stocks, Pitkowsky says.
Thomas says the dominance of growth stocks over value started in late 2006, which was the last time value stocks outperformed growth.
“Part of it was every trend sows the seeds of its own demise, so if you go back to late ’06, the value index was very heavily focused in financials. Then we had the financial crisis; that was the unraveling of a lot of the excess that was in the value index,” Thomas says. “In this cycle that we’ve had, it’s really been difficult to find top-line growth because the economy is somewhat weak, so companies that deliver (top-line growth) have been rewarded.”
The trend toward investors seeking out passive index-type investing over active-manager investing may also be responsible, too.
Mark Travis, president of Florida-based Intrepid Capital Funds and lead manager for the Intrepid Capital Fund (ticker: ICMBX), says the ultra-accommodative Federal Reserve and other global central bank policies since the financial crisis have supported asset values in the stock market, making it difficult to find true bargains out there.
“Valuations are still tough because of central banks’ policies have made everything look cheap, so you have to look hard,” he says.
If the total returns of the different fund categories hold out, 2016 may be the change value managers seek.
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Digging out value. Investors are starting to look toward value’s way, but they’re not yet convinced to jump in.
Thomas says when he talks to financial advisors, they’ll tell him they’re seeing the change and planning to make the shift in their clients’ portfolios, but many haven’t quite yet done so.
“Quite often it takes some relative performance to shift things around a bit,” Thomas says.
What that means is that value stocks don’t have to outperform growth in a market where prices are rising, but that value will do well compared to growth when overall prices are holding steady or even falling.
Many investors equate value stocks with defensive plays, but that’s not necessarily accurate. This year defensive plays have been some of the most richly valued.
“If you look at (what’s)…. worked year to date, it’s been utilities and real estate investment trusts,” Thomas says. “If we talk to our value managers, they tell us these areas are looking expensive, and there other parts of the value index that offer more opportunity.”
Trauner says since so many investors have piled into companies where they think underlying businesses is highly recession-resistant, these companies are experiencing extreme valuations. Investors who buy those securities now won’t earn a good return, he says.
Instead, value managers like to look at sectors that are unloved by other investors. For Pitkowsky and Trauner, those areas include companies that will benefit from higher interest rates.
“After eight years of zero interest rates, people have given up on the idea of rates going up,” Trauner says.
In this area, one stock they think is attractive is Leucadia National Corp. ( LUK), a holding company that owns investment bank Jefferies and other assets.
“Jefferies is a broker-dealer, an asset manager, who will benefit from higher rates. They have a great history, great management (and had) a solid quarter. If rates rise, odds are it will help them to return to a better profit picture,” Pitkowsky says.
Travis says there are three companies he likes. The first is Royal Mail Group, the privatized British mail system that trades on the London stock exchange. While the company still is converting to being a private company from a public entity, they have do a lot of package delivery and have good assets like undervalued real estate in central London and their pension is overfunded, he says.
Second is Corus Entertainment, which runs predominately women and children’s programming in Canada and trades on the Toronto exchange. Travis says Corus has been overly punished by the idea of unbundling cable TV.
He says since these companies are foreign, he also hedges the currency exposure to avoid losses related to foreign-exchange trading.
The last firm is oil-fields company Patterson-UTI Energy ( PTEN). Travis says the oil rigs it owns are worth more than where the company is valued.
Travis admits it’s difficult to be a value investor because it means buying stocks that no one else wants and being patient for these stocks to rebound.
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“We are waiting for these companies to (eventually) perform. We’re not waiting for the next quarter,” he says.
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Why Value Stocks Are a Good Buy for Investors originally appeared on usnews.com
