Why Relative Value Is Trumping Risk Aversion

by: Russ Koesterich, CFA

Despite recent rising geopolitical tensions, stocks haven't completely followed the typical "risk-off" script, and a number of high-risk segments have performed relatively well. The simple reason: Investors have found a newfound interest in relative value. Russ explains and shares which market segments potentially offer this value.

The stock market has had a less-than-positive tone the last three weeks, thanks to rising geopolitical tensions. However, trading has not been all about risk aversion or getting "defensive." In other words, stocks haven't completely followed the typical "risk-off" script.

Gold, a classic safe-haven asset, remains well below its spring highs, and certain defensive sectors - notably utilities, telecommunications and health care - have struggled month-to-date. Meanwhile, a number of higher-risk segments of the market, such as frontier markets and emerging market (EM) stocks in Asia, have performed relatively well.

How do you reconcile these two trends? As I write in my new weekly commentary, "Reasonable is the New Cheap," the seeming disconnect between investor angst - evidenced by a sideways stock market, rising volatility and selling of high-yield bonds - and a proclivity for more exotic markets can be reconciled fairly simply: investors have a newfound interest in relative value.

At a time when most of the major asset classes look somewhere between fully valued and expensive, investors are being forced to look further afield in search of value and yield.

As such, relative value, which I've long been advocating investors focus on, seems to be gaining traction, and it's having an impact on how investors are behaving. Put differently: In a world where most investments look expensive, reasonable is the new cheap.

EM Asia is illustrative of this point. This market segment has benefited from stabilization in the Chinese economy and positive election results in India, but there is another reason investors have been attracted to this part of the world: It's relatively cheap. While EM Asia valuations - as measured by the MSCI Emerging Markets Asia Index - are still above the bargain basement levels seen in 2008, they trade at a 30% discount to developed markets.

Looking forward, I expect the focus on relative value to continue, and I continue to believe that investors should focus on those market segments that are more reasonably priced.

In particular, I see value in select international markets, particularly Japan and emerging Asia; international and global dividend funds; large and mega caps; and certain cyclical sectors. You can read more where to potentially find relative value in my latest monthly Investment Directions market outlook commentary.

What questions do you have about relative value? Where do you see relative value today? Share your thoughts below.

Sources: Bloomberg, BlackRock Research

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