Investors Can Plant the Seeds for Outperformance in Value Stocks

Since mid-2018, economically sensitive and cyclical names have been hard hit by uncertainty stemming from the trade war, falling interest rates, and late cycle fears. The disparity in valuations between these shares and large technology stocks was turbo charged last spring by investors reacting to the pandemic, resulting in historically high valuation dispersion. News of an effective vaccine in November 2021 finally gave the market visibility to a path out of the pandemic, and the outperformance of value stocks since then has been significant.

This pattern of behavior is not new. Value typically underperforms going into a recession when there is uncertainty around the severity and duration of economic impact. For the disciplined value investor, these darkest periods – when sentiment is lowest – provide the opportunity to plant the seeds for outperformance through fundamental research. Once fears give way to facts, the companies cast out of favor re-rate, and in fact become momentum stocks themselves.

As this scenario plays out yet again, investors find themselves asking the following questions:

  1. How long will the value rally last?
  2. How much more can value stocks outperform after such a steep rally?

While there is no way to answer these questions with certainty, history suggests that there is plenty more to come.