By Nick Kalivas
Today's macro backdrop - including corporate actions, geopolitics, valuations and growing investor interest in value-based funds - leads me to believe that the style of the market could favor value over growth in the coming months.
Corporate actions may unlock value
Themes that have historically favored value are present in today's market, including buybacks, spin-offs, mergers and acquisitions, which all have been powerful drivers of return. When a company's stock is trading for less than its intrinsic (or actual) value, it presents management with the opportunity to enhance shareholder wealth and expand valuation multiples through corporate actions.
Examples of recent shareholder-friendly actions aimed at unlocking value include:
- On July 21, Johnson & Johnson (0% holding of the PowerShares Dynamic Large Cap Value Portfolio ETF (NYSEARCA:PWV), as of June 30, 2014) reported a $5 billion share buyback program.
- On July 23, EMC (0% holding of PWV, as of June 30, 2014) said it expected to buy back $3 billion in stocks in 2014, up from a prior projection of $2 billion.
- On July 24, 3M (0% holding of PWV, as of June 30, 2014) cut its 2014 view of capital expenditures, while raising the lower end of its 2014 buyback range $500 million.
- For the month of July, (through the 25th) M&A announcements in North America totaled $202 billion, compared with $115 billion in July 2013.
- According to Bloomberg, there have been 46 spinoff announcements in 2014 between Jan. 1 and July 25. A year ago, there were 32 spinoff announcements during the same period.1
Geopolitics is breeding uncertainty
In my opinion, the attractiveness of value investing may be further highlighted by the current geopolitical uncertainty in the Ukraine and Middle East. Economic sanctions against Russia could cool global economic growth by reducing trade flows, while turbulent headlines from the Middle East could undercut consumer and business confidence, creating a drag on profit growth. The potential for a rocky economic landscape may cause investors to seek companies that are inexpensively priced relative to their fundamentals in an effort to reduce the risk profile of their equity portfolio.
Money is flowing toward value
Growth has become more expensive. Since the market bottom in February 2009, the S&P 500 Value Index P/E ratio has expanded from 13.2 to 15.5 (+2.3), while the S&P 500 Growth Index P/E ratio has risen from 10.0 to 21.4 (+11.4).1 At 138%, the P/E spread ratio between the S&P 500 Growth Index and the S&P 500 Value Index is above the mean of 131% and median of 128%.2
Given recent trends in money flows, it appears investors are seeking value. Year to date, flows into value exchange-traded funds (ETFs) have outpaced flows into growth ETFs by 2.5 times ($4.2 billion versus $1.7 billion).3 On the mutual fund side, Morningstar indicates growth funds have seen outflows of $24.0 billion, while value funds have seen inflows of $5.1 billion year to date.4
Valuations are stretched
Expanding price-to-earnings ratios (P/E) in the wake of slow economic growth may cause investors to be more conscience of valuation. The P/E multiple on the S&P 500 Index has expanded from 10.9 in March 2009 to a recent high of 18.3.1 The 2008 financial crisis and 2000 technology bubble still linger in the mind of investors.
During her semi-annual testimony to Congress on July 15, US Federal Reserve Chair Janet Yellen indicated that equity valuations of smaller companies, as well as social media and biotechnology firms, appeared stretched. But she also noted that the overall equity market valuation was close to its historical norm. Given this assessment by the Fed, I believe value investors should consider focusing their attention on the large-cap sector.
Gaining large-cap value exposure
The PowerShares Dynamic Large Cap Value Portfolio provides access to the value factor in an ETF structure. Find out more about PowerShares Dynamic Large Cap Value Portfolio.
- Bloomberg L.P., as of July 25, 2014
- Bloomberg L.P., as of July 23, 2014 [based on data since January of 2005]
- Bloomberg L.P., as of July 24, 2014
- Morningstar, as of July 23, 2014
A buyback is the repurchase of outstanding shares by a company in order to reduce the number of shares on the market.
A spin-off is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company.
Stock price-to-earnings ratio is the share price divided by earnings per share. It is measured on a 12-month trailing basis.
A value style of investing emphasizes undervalued companies. There is a risk that the valuations may never improve or that the returns on value equity securities will decrease.
A growth style of investing may be more volatile than other types of investments.
Investments focused in a particular industry are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.
The S&P 500® Index is an unmanaged index considered representative of the US stock market. An investment cannot be made directly in an index.
The S&P 500® Value Index consists of stocks in the S&P 500 that exhibit strong value characteristics based on four value and three growth factors.
The S&P 500® Growth Index consists of stocks in the S&P 500 that exhibit strong growth characteristics based on three growth and four value factors.
The Russell 1000® Value Index is an unmanaged index considered representative of large-cap value stocks. The Russell 1000® Value Index is a trademark/service mark of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co.
The Dynamic Large Cap Value Intellidex Index is designed to provide capital appreciation while maintaining consistent stylistically accurate exposure. The Style Intellidexes apply a rigorous 10-factor style isolation process to objectively segregate companies into their appropriate investment style and size universe.
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