Tue, 09/29/2020 – 15:10
Noting that in September value finally started to show signs of life, reversing the trend by 4ppt MTD, Bank of America’s chief equity strategist Savita Subramanian writes that value “still see more room to run for several reasons” the main of which is that BofA still views the economy as continuing its recovery, a cycle phase which traditionally supports cyclicals over defensive sectors.
A second reason for the value bet is that value has outperformed coming out of 14 of the last 14 recessions for at least three months.
Reason three is that BofA’s proprietary Regime Indicator has officially entered into a recovery phase…
… where Value outperformed 100% of the time by over 20ppt on average during this phase, with Growth lagging in previous Recovery phases, with average relative returns of -8.5%. In the first “official” month of a Recovery (i.e. after two consecutive months of improvement from the Downturn phase), Value has historically outperformed Growth and Quality by over 3ppt on average.
Despite its recovery optimism, BofA admits that it is too early to write out Growth stocks just yet: as Savita writes, “despite our Value preference, there is still a number of compelling arguments supporting Growth’s continued leadership. The Fed put (FANG stocks have been the ultimate beneficiaries of monetary stimulus), Tech disruption and the rise of ESG investing favor Growth over Value. A potential second wave also does not bode well for Value.”
Additionally, the bank notes that when growth is scarce, investors will pay up for growth. As growth broadens out, investors become more price sensitive and seek out the cheapest growth they can find.
And contrary to popular belief, Subramanian writes, “rates have very little impact on style rotations.”
Another historical observation: during the recovery phase, value has outperformed growth in all but two instances during the trough to peak profit periods.
Meanwhile, BofA warns that given the lack of fiscal stimulus (for now), Growth stocks will not be immune to a second wave and could potentially see more downside, especially given rich valuations and positioning.
Positioning also suggests that value has more upside thatn growth, as active managers maintain a near-record overweight in Growth sectors like TMT and a near record underweight in Value sectors like Financials. FANG carries an overweight of 1.7x by hedge funds, and 1.8x by long only mutual funds. At the same time, banks are at a post–GFC record underweight: “On almost any measure, and among almost every investor group, Growth is over-owned and Value is neglected.”
Predictably, when look at from a valuation standpoint, the aptly named Value stock are far cheaper (i.e., undervalued) than growth. In fact, as shown in the chart below, value sits close to the deepest discount to Momentum. The only other instances during which Value traded at such a steep discount were 2003 and 2008, after which Value outperformed Momentum by 22ppt and 69ppt, respectively, over the subsequent 12 months.
Another compelling reason to go long value: as Growth has grown pricier and Value has grown cheaper, valuation dispersion has risen to the highest levels since the GFC. According to BofA, “when valuation dispersion has been this high or higher, Value stocks have outperformed Growth 95% of the time over the subsequent 12 months, by 24ppt on average.”
One final reason to be long value: Japanification. While not its base case, BofA writes that similarities to Japan (low rates, aging demographics, a closing economy, deflationary threats and a range-bound market) are hard to ignore. In such a case, Japan factor performance during the 1990s’ “Lost Decade” indicates that Value was the best performing factor among the standard quantitative strategies.
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At the same time, BofA also advises its clients to stay away from value traps: to do that, it presents its Value Trap model which attempts to steer investors out of stocks that are inexpensive for the wrong reasons: prices are falling faster than analysts are cutting earnings expectations. These are the industries which tend to remain trapped until a catalyst propels them upward. Also, since 1996, these industries have underperformed the benchmark by 4% annually and have failed to outperform the market more than half of the time. According to Subramanian, more than half of the time, industries that are identified as Value traps have failed to outperform the market in the subsequent month, and performance of Value Traps relative to the benchmark have underperformed by 4ppt p.a.
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With all that in mind, here are Bank of America’s 29 top Quality Value stocks to buy and eight Value Traps to avoid. As BofA notes, “these Quality Value stocks offer attractive yields (3.4% on avg.), which analysts believe dividends are mostly secure, as well as compelling fundamental drivers.”
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Author: Tyler Durden