Is there value left in the value trade?

Moreover, this performance dispersion between the two styles of investing actually widened in 2017. Last year (performance in GBP terms), the MSCI World Value Index returned 7.7 per cent versus 17.3 per cent for the MSCI World Growth Index.

Inevitably, the extended cycle of value’s relative underperformance versus growth has raised questions among some investors as to whether the ‘value trade’ is worth the wait. Indeed, some challenge the very idea of market cyclicality itself.   It is no coincidence that as longer term bond yields have fallen, growth stocks have outperformed.

Over the last 15 years, the relationship between value, growth and bond yields seems well established. In fact, the term ‘value trade’ could be interchanged with ‘the higher yield trade’.

We believe that the patient investor is beginning to be rewarded.

The persistence of abnormal market conditions, which have been characterised by low growth, low interest rates and low volatility have encouraged investors to favour higher risk premia in search of return and yield.

Reinforcing this trend, we have seen the entrance of price insensitive buyers, namely central banks and passive investment vehicles, which through their buying programmes make no distinction between the underlying value of assets.

In effect, all of these actions create too much efficiency within the market, leaving little room to find mispriced stocks.  

These are all important considerations because if we are to believe that interest rates are moving higher, then it would seem logical to expect stronger performance from the more value-orientated parts of the market. In our view, the market narrative is shifting towards higher interest rates as cyclical inflation pressures rise.

While nascent signs emerged during the second half of 2016, triggered by the Bank of Japan moving away from negative interest rates and perceptions of a reflationary environment following Donald Trump’s victory, the difference this time is that central banks have moved further along on the tightening journey, led by the US Federal Reserve.

These policy actions are being taken against a backdrop of global growth that has seen some acceleration of late amid rising corporate profitability. The effects of tighter global monetary policy are likely to lead to lower levels of liquidity and potentially higher levels of volatility as interest rates rise.  

Aside from macroeconomic factors, we should also consider that largest sectors in the MSCI Word Value Index have experienced significant structural change in the post-financial crisis years, such as financials and energy.

Not only should these sectors benefit from a reflationary environment and rising longer-term interest rates, but we also expect to see some lifting of the regulatory burden – a factor that has weighed heavily on the banking industry in particular.

Furthermore, investors should view valuation opportunities from a regional perspective as well as sector. Within developed equity markets, Europe and Japan have trailed the US in terms of the corporate earnings recovery cycle and we expect to see these markets continue to recover as economic conditions improve.  

Far from the cycle being dead, we believe that the patient investor is beginning to be rewarded.

Benjamin Matthews is investment manager at Heartwood Investment Management