Why Value Has Stopped Outperforming

Russ Koesterich, CFA profile picture
Russ Koesterich, CFA
3.47K Followers

Summary

  • Historically, the best time to overweight value stocks has been in the early stages of a recovery, when economic growth is accelerating, and value tends to be cheap.
  • Aside from energy, few sectors or styles have produced positive returns in 2022, but until recently value consistently outperformed.
  • A cooling economy and bond market reversal have resulted in value now trailing more defensive investment styles.

Digitally enhanced shot of a graph showing the ups and downs shares on the stock market

shapecharge

Originally published on July 13, 2022

Russ Koesterich, CFA, JD, Managing Director and member of the Global Allocation Team explains why value stocks have gone from market leader to laggard.

The market has been in a persistent downtrend since the second trading day of the year. Following a solid first day, stocks quickly reversed and have been grinding lower ever since. But until recently it was not all stocks: Value stocks offered a degree of protection. That changed in June, with value going from leader to laggard. To the extent investor fears are shifting from inflation to recession, a quick value recovery is unlikely.

Value hits the “recession” wall

Aside from energy, few sectors or styles have produced positive returns in 2022, but until recently value consistently outperformed. From the start of the year through the end of May the Russell 1000 Value Index outperformed the broader U.S. market and growth indexes by roughly 8% and 17% respectively. The catalysts for the outperformance were cheap valuations, a strong economy and rising interest rates.

What changed? Simply put: the source of investor anxiety. While inflation remains a stubborn problem, inflation expectations are falling fast. Since mid-June, five-year inflation breakevens, derived from the Treasury inflation protected securities (TIPS) market, have fallen by more than 0.50%, from nearly 3.2% to roughly 2.6%.

As inflation expectations have dropped, so have real-time measures of economic activity. The ISM Manufacturing New Orders Index, one of the most closely watched leading economic indicators, has plunged to just below 50. A broad recession is still not assured, but manufacturing is slowing on the back of falling consumer demand and excess inventory.

Apart from a rapidly decelerating economy, value has lost another tailwind: rising rates. Bank stocks, which benefit from higher rates and a steeper yield curve, led the market earlier in the year. Along with energy and materials, banks were viewed as a haven in an environment of higher inflation and interest rates. However, with lower rates and a narrower yield curve, banks have surrendered much of their gains. Banks turned sharply lower in June and are now underperforming the market year-to-date by approximately 4.50%.

A cooling economy and bond market reversal have resulted in value now trailing more defensive investment styles. In June, value underperformed both the broader market and growth. Instead of value, investors are seeking safety in low-volatility and high-dividend paying stocks (see Chart 1).

MSCI World factor index 1-month performance

Chart image

Source: Refinitiv Datastream chart by BlackRock Investment Institute, Jul 04, 2022

Out of phase

Historically, the best time to overweight value stocks has been in the early stages of a recovery, when economic growth is accelerating, and value tends to be cheap. Today is not that time. Whether we can avoid a full-blown recession is still an open question, but the headwinds from higher energy, food and interest rates will result in slower growth. At the same time, growth has surrendered its “pandemic premium,” making value less attractive on a relative basis. For investors looking to ride out what is likely to be more volatility, focus on more defensive styles: quality, growth at a reasonable price (GARP) and low volatility. Leave value for the next upturn.

This post originally appeared on the iShares Market Insights

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

Russ Koesterich, CFA profile picture
3.47K Followers
Russ Koesterich, CFA, JD, Managing Director and portfolio manager for BlackRock’s Global Allocation Fund, is a member of the Global Allocation team within BlackRock's Multi-Asset Strategies Group. He serves as a member of BlackRock's Americas Executive Committee. Mr. Koesterich's service with the firm dates back to 2005, including his years with Barclays Global Investors (BGI), which merged with BlackRock in 2009. He joined the BlackRock Global Allocation team in 2016 as Head of Asset Allocation and was named a portfolio manager of the Fund in 2017. Previously, he was BlackRock's Global Chief Investment Strategist and Chairman of the Investment Committee for the Model Portfolio Solutions business, and formerly served as the Global Head of Investment Strategy for scientific active equities and as senior portfolio manager in the US Market Neutral Group. Prior to joining BGI, Mr. Koesterich was the Chief North American Strategist at State Street Bank and Trust. He began his investment career at Instinet Research Partners where he occupied several positions in research, including Director of Investment Strategy for both U.S. and European research, and Equity Analyst. He is a frequent contributor to financials news media and the author of two books, including his most recent "The Ten Trillion Dollar Gamble."Mr. Koesterich earned a BA in history from Brandeis University, a JD from Boston College and an MBA from Columbia University. He is a CFA Charterholder.

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