Value Stocks Are Still Not Attractive

by: Evariste Lefeuvre

Summary

There is no mystery in the ongoing behavior of value stocks against growth.

It reflects a combination of low 10-year yields and a strong dollar, both of which are positive for growth stocks.

As long as U.S. Treasury yields and the U.S. dollar will remain negatively correlated, value stocks may not outperform.

Since the Fed started mentioning tapering, the relationship between the relative performance of value against growth and U.S. Treasury yields has broken down at least twice (see chart below). Episodes of higher yields should have benefited value stocks but did actually not.

Yet, taking a long view, the long lasting underperformance of value is not really surprising - value stocks have suffered from the long decline in U.S. Treasury yields: conundrum, great recession, secular stagnation…

Contrary to the late 1990s, the outperformance of growth is not linked to any bubble (Internet stocks in 98/99). From this perspective, only a significant reversal in U.S. long term yield would call for a structurally long position on value against growth. Once again the arbitrage for value when yields are going up is not linked to the growth expectations embedded in long term yields (which would call for growth stocks to outperform) but rather on the yield arbitrage (growth stocks have a much lower E/P hence a required price adjustment that is much significant than that of high E/P value stocks).

The ongoing strength of the U.S. dollar also explains the relative strength of growth stocks. As can be seen below, bullish trends for the USD are generally positive for growth sub-indexes.

On a three-month basis, the recent behavior of the USD would yet suggest either that growth-stock outperformance is overdue or that stocks are pricing a sharp rebound in the U.S. currency.

Bottom Line: There is no mystery in the ongoing behavior of value stocks against growth. It reflects a combination of low 10-year yields and a strong dollar, both of which are positive for growth stocks (at least on a relative perspective).

The question is therefore not about any "weird" behavior of value stocks but rather about the nature of the relationship between 10-year yields and the USD: how long will U.S. Treasury yields and the U.S. dollar remain negatively correlated? The chart below suggests that the correlation break is close to be the longest ever. As long as it lasts, value won't be attractive.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.