To those who fear market have already priced in a lot of good news, especially on the « Trump » effect on the macro backdrop, and that maybe the « Value » trade is now overcrowded and associated sector rotation (from defensive names to more cyclical ones) is overdone, Morgan Stanley’s equity strategy team, lead by Graham Secker, has some good news. Actually 6…
« The outperformance of Value has to slow from here we think. However, we see 6 reasons why Value is likely to outperform as we go through 2017. These include a favourable macro backdrop and that Value stocks’ relative price, valuation and EPS remain very depressed given we’re coming off of the longest and deepest period of Value underperformance ever seen. Also, we calculate that the average Value rally lasts 27 months and sees 27% outperformance – since its trough in July, Value has outperformed by 8% over 6 months. »
Of course, there are no guarantee that past performance will continue in the future (and that’s a huge caveat that every investor should bear in mind).
In a report dated Jan 10, the 6 reasons are the following :
#1-Value underperformance relative to growth stocks/sectors has been the largest since 1970, and there should be room for outperformance from there.
#2-Value stocks look depressed on valuation metrics but also on fondamentals and relative price.
#3-On average, value outperformance cycles « tend to last 27 months with 27% upside ». Current cycle has run for 6 months with 8% outperformance so far. Again, what happened in the recent past will not automatically repeat itself in the near future.
#4-Value EPS growth should accelerate in 2017. That’s far from a no brainer, since for the last 6 years, earnings expectations have systematically been revised down in Europe… Why would that change ? Well most of it falls back to the macro backdrop, which many say is improving (most leading indicators, such as PMIs, money/credit distribution, unemployment, consumption and sentiment are improving in Europe).
#5-The macro backdrop remains so far the strongest factor playing in favour of value. Rising rates since July 2016 have been behind the sector rotation that we saw in financial markets (not only a European event BTW).
#6-« Momentum » is playing in favor of Value. That’s probably not a surprise, but so far people want to keep on dancing on the « Value » tune the market have been playing for the last 6 months…
Althoug interesting, the note lacks a note of prudence, especially by focusing on what could make all this optimistic outlook go wrong.
Market participants tend to forget that there are still major risks playing around in the economy, such as the high level of leverage in the financial system, the lack of productivity growth and of course, the demographics. Last but not least, the divergence of monetary policies in the developed world could well breath life to market volatility in 2017, and very few investors seem to pay attention to it.