Could we soon see the start of a new value cycle?

Could we soon see the start of a new value cycle?

Over the past two weeks, my team has gotten many questions about the impact that a Biden administration could have on various areas of the stock market — and whether we might soon see a new era of value outperformance. We’re not ready to declare the start of a value cycle just yet. But we believe that a US fiscal stimulus package and, more importantly, a globally available COVID-19 vaccine would both be very positive developments for value stocks.

While we watch the Senate runoff races in Georgia, which will decide which party controls the Senate, there is increasing talk about a fiscal stimulus package during the lame-duck session of Congress.  Even if a stimulus deal is not reached prior to the new administration taking office, we believe it would be in the best interest of Congress to agree to a deal in early 2021. Regardless of the exact timing, we would expect a fiscal stimulus package to be positive for value stocks by increasing economic activity in areas largely hurt by the pandemic.

Ultimately, we believe the most important factor that could help propel value stocks into a new cycle is the mass, global distribution of effective vaccines.  This would allow economies to more fully reopen and normalize the demand that is needed for economic growth. In turn, this would also enable healthy levels of inflation, which would raise real rates. As we’ve seen throughout history, regardless of who is in the White House or who controls Congress, the market and business cycles continue.

Update on value performance

Leading up to the presidential election, one thing was clear — the stock market tends to punish uncertainty and reward clarity. Post-election, the markets have clearly rewarded the more likely scenario of a divided government (assuming the Republicans retain control of the Senate after the Georgia runoff elections).

As you can see, from the chart below, value has outperformed growth several times year-to-date. This is shown as the sharp peaks in the line, which illustrates the daily price difference between the S&P 500 Growth Index minus the S&P 500 Value Index. It is interesting to note that starting in September, we’re seeing the downward trajectory starting to level-off.  Furthermore, as we’ve seen the market hit new highs after the election, we’ve also seen a rotation toward value stocks from October through the middle of November.  (That being said, we’ve seen this occur over shorter periods since the COVID-19 market meltdown in the first quarter.)

Will this be the start of a new value cycle?  As value investors, we’re not going to wave the victory flag, at this point. However, we know historically that value and growth have moved in cycles, so based on history we’re confident at some point value will assume leadership.

Value has outperformed growth several times this year

The overall downward trend of value compared to growth has leveled off since September

12.1 Could we soon see the start of a new value cycle Figure 1
Source: Lipper. Data shown is from 12/31/19 to 11/09/20.  The line represents the daily price difference between the S&P 500 Growth Index minus the S&P 500 Value Index. An investment cannot be made directly in an index. Past performance does not guarantee future results. The S&P 500® Growth Index consists of stocks in the S&P 500® Index that exhibit strong growth characteristics based on three growth and four value factors. The S&P 500® Value Index consists of stocks in the S&P 500® Index that exhibit strong value characteristics based on three measures: book value-to-price, earnings-to-price and sales-to-price.

Post-election: What we’re watching as value investors

Now, let’s take a look at some of the potential impacts that a Biden administration may have on various sectors. Some of these may or may not come to pass — but they’re important issues for each sector to monitor.

Energy

  • We could see a possible fracking ban on federal lands. Although Biden retracted his original statements on a full ban, this remains a concern.
  • We see the potential for eliminating new oil/gas leases on federal lands (and maybe rescinding existing leases).
  • New sales of electric vehicles could be promoted through mandates.
  • Climate-related disclosures could be mandated for public companies.
  • Environmental costs may be included in royalties paid on federal lands.

Utilities

  • Increased economic activity could lead to rising rates, and utilities historically have had a negative correlation to rising rates.
  • Utilities could face increased competition from renewable energy firms, denting their pricing power.

Information technology

  • If the corporate tax rate rises, technology stocks could be particularly impacted, considering they have some of the lowest effective tax rates.
  • Some progressives have called for the government to break up some of the largest tech companies.
  • With an economic recovery, the risk of rising rates may bring down tech company valuations.

Industrials

  • A broad, national infrastructure bill could help companies in this sector.
  • In particular, renewable energy infrastructure (such as solar, wind, and hydrogen) may benefit from the Biden administration’s desire to support an energy transition.

Financials

  • If a fiscal stimulus causes increased economic activity and higher rates, we would expect large banks to be the largest beneficiaries.
  • Assuming the Republicans retain the Senate, a split Congress would likely keep Elizabeth Warren in the Senate (versus joining Biden’s cabinet). This could dampen the fear over excessive regulation or taxation of the large banks. However, there may be the risk of Biden appointees having a negative effect on banks, for example, by mandating a higher capital requirement for them to meet.
  • An increase in corporate taxes would also affect the large banks. However, we see this as less of an issue if it is accompanied by a stimulus bill and/or stronger economy.

Health care

  • An increased focus on drug pricing will likely to continue regardless of which party controls the White House and Senate.
  • Pending the final make-up of the Senate, we believe there is a lower probability of dramatic increase in corporate tax rates, which is a positive for domestic health care companies (managed care and health care providers are good examples).
  • With a divided government, wholesale changes to the Affordable Care Act (Obamacare) and/or more significant policy changes like Medicare for All or a broad public option are also less likely. This would reduce pricing/reimbursement risk across health care services.

All investing involves risk, including the risk of loss.

Book value is a company’s total assets minus liabilities and intangible assets. A book-to-price ratio is calculated by dividing the book value of a firm relative to its market value.

An earnings-to-price ratio is calculated by dividing the earnings per share of a company’s common stock divided by the market price of the stock.

A sales-to-price ratio is calculated by dividing a company’s market capitalization by the company’s total sales over a trailing 12-month period.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources.

Short-term volatility in energy prices may cause share price fluctuations.

Investments in financial institutions may be subject to certain risks, including the risk of regulatory actions, changes in interest rates and concentration of loan portfolios in an industry or sector.

The health care industry is subject to risks relating to government regulation, obsolescence caused by scientific advances and technological innovations.

Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.

The opinions referenced above are those of the author as of Dec. 1, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

Credit: Invesco

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