“Year of the vaccine” expected to prompt rotation into value stocks


Investors piled back into value stocks as November’s twin breakthroughs in the search for an effective vaccine against Covid-19, by Pfizer/BioNTech and Moderna, renewed optimism and prompted a huge rally in global markets.

Value investing has been out of favour this year as the strategy typically favours companies that are more sensitive to economic cycles, such as energy companies and banks. 

A turnaround in November saw the Russell 1000 Value Index rise by 13.2 per cent, outperforming the Russell 1000 Growth Index, which only registered a 10.1 per cent rise over the month.

The year 2021 has already been named “the year of the vaccine” by Bank of America in its monthly survey in November, and the bank says it expects value stocks to outperform growth stocks, and for small-cap stocks to beat large-cap stocks over the year.

Ian Lance, co-portfolio manager of Temple Bar Investment Trust, and portfolio manager at RWC Partners, believes that a vaccine could be “the catalyst” for a sustained move toward value investing.

“As the Pfizer vaccine receives UK regulatory approval, and with it the promise of return to a somewhat normal life, now may be the signal many investors have been waiting for to re-allocate away from growth to value,” says Lance. 

He notes that many investors have given up on the idea of a sustainable rotation from growth to value, one that would persist for an extended period. 

“However, the recent bounce in value following initial vaccine announcements, spurred on by UK equities trading at their greatest discount for 50 years, and the nature of the UK stock market (being a classic value market) indicates that the rotation may persist.”  

Morningstar found that UK funds, which often have a strong value tilt, were making a comeback in November, led by Ninety One UK Special Situations fund.

Lance says recent movements have at least shown investors the “dangers of a ‘one bet’ portfolio in which mixing bonds with bond-like equities fails to provide any diversification and both do poorly in a reflationary environment”.

The optimism for 2021 was shared by Jens Wilhelm, the member of Union Investment’s board of managing directors responsible for portfolio management, who says: “The economic recovery should benefit both cyclical sectors and value stocks over the course of the year.”

Meanwhile, William Davies, chief investment officer, EMEA at Columbia Threadneedle Investments, warns against a rush to value and poorly performing stocks “irrespective of the outlook”.

“Volatility will likely continue to be elevated in 2021, but it would be a mistake to make knee-jerk reactions to sudden strong moves in markets,” says Davies.

Davies points out that value stocks also performed very well during the “sugar rush” in markets at the end of the global financial crisis in 2009. Davies says this is “being mimicked somewhat today” but warns that recent stimulus packages and government intervention will lead to higher levels of debt than after 2009.

The global debt load has already increased by USD15 trillion in the first three quarters of 2020 and the global debt-to-GDP ratio is expected to reach 365 per cent by the end of the year, according to the Institute for International Finance. 

“We will thus emerge into a world of low inflation, low growth and low interest rates – a repeat of the 2010s in some way. Such a backdrop is not one where traditional value is likely to outperform over the longer term,” says Davies.

Ivo Nenin, director and portfolio manager at Commonfund Asset Management,  notes that value investing typically outperforms at the beginning of a market recovery “when economic and sentiment conditions have just bottomed”.

“Investor sentiment has already turned bullish and earnings from value companies continue to lag,” he adds, observing the recent outperformance of the S&P 500 energy and financials sectors compared to the S&P 500 technology, communication services and consumer discretionary sectors.

“While economic activity continues to recover despite increasing cases of Covid-19 infections, the environment does not appear strong enough to support continued outperformance of value equities yet,” says Nenin. 

The IMF has predicted that global GDP will slump by 4.4 percent in 2020. It projects that this will recover to growth of 5.2 percent in 2021, but has warned that “uncertainty surrounding the baseline projection is unusually large”.

“Additionally, successful containment of Covid-19 is still elusive, creating headwinds for further economic growth and traditional value sectors like energy companies. Similarly, central banks remain committed to ultra-low interest rates, negatively impacting earnings for the financial sector.” Nenin continues to favour a “balanced approach towards growth and value factors”.

Andrew McCaffery, global CIO of asset management at Fidelity International, warns that “investors consistently chose to believe the best-case scenario” in 2020, buoyed by liquidity from central banks. 

“I am concerned that this optimism will not always be matched by the economic reality of 2021,” says McCaffery. “A huge amount of investment has been brought forward to sustain shuttered economies and, given the likelihood of a divided US Congress, a limited fiscal stimulus package could mean a slower recovery. There is a risk in the near term of a double-dip recession in the US if more restrictions are imposed to tackle the virus while the world waits for vaccines to be delivered across populations.”

This could also cut short the value investing rally, as value stocks tend to rise with the economy.

“Depending on the virus’s evolution, a vaccine and any policy response, there may be sharp rotations from non-cyclicals to cyclicals or vice versa, though banks and oil companies will remain under structural pressure,” says McCaffery.