Value Stocks Get Back in Gear
economic slowdown

Value Stocks Get Back in Gear

Stocks caromed around Wall Street like billiard balls knocked out of a rack over the past week as investors celebrated positive earnings results from major tech companies while at the same time bemoaning weak numbers out of some major industrials.

Through the Thursday close, advancers and decliners were evenly matched. There were 333 new one-year highs vs. 91 new lows.

Topping the new high list were:

  • Apple (AAPL)
  • Procter & Gamble (PG)
  • AstraZeneca (AZN)
  • GlaxoSmithKline (GSK)
  • Novo Nordisk (NVO)
  • Raytheon (RTN)
  • Applied Materials (AMAT)
  • Lam Research (LRCX)
  • Phillips 66 (PSX), and …
  • Valero Energy (VLO)

We’re finally seeing a more risk-on list of leaders. Valero can really rip when it gets going, and it’s considered a value stock now with a forward PE multiple of just 10.1 and price to sales multiple of just 0.35.

In economic news, jobless claims came in at 212,000 in the week ended Oct. 19. This is below the consensus estimate of analysts polled by Econoday for 214,000, and fewer than the previous reading which was a revised 218,000. Good news, as the health of the economy is tightly correlated with claims.

So far in the reporting season, companies in the S&P 500 have mostly managed to beat analysts’ estimates. But expectations were quite low heading into the fourth quarter in response to a slowing global economy and the confusing U.S.-China trade fight.

The Wall Street Journal reported that UBS expects there will still be a meaningful economic slowdown in the first half of 2020. And that’s even if the two countries manage to strike a firm deal to roll tariffs back by the end of this year.

Even if UBS is right, though, it still doesn’t mean stocks will slide. A possible deal has become the consensus and may already be cooked into prices.

Investors have been largely cautious as indexes have reached the top of their one-year ranges. With results from nearly 20% of the companies in the S&P 500, earnings are projected to decline 4.7% for the third quarter year-over-year, according to FactSet.

This would mark the third consecutive quarter of declining profits and would inflame fears that the U.S economic growth is slowing.

But those fears aren’t unfounded. In fact, let’s take a look at two important ETFs for more insight …

Value Village

The new financial data website Koyfin sports a box on its homepage that shows which broad financial factors were the most successful in the market on any given session.

On Tuesday, it showed that value far outpaced growth and small stocks outpaced large stocks.

The Koyfin finding was corroborated by the performance of two opposite funds: iShares Edge MSCI U.S.A. Value Factor ETF (VLUE) outpaced iShares S&P 500 Growth ETF (IVW) +0.6% to -0.8%.

Jason Goepfert of SentimenTrader.com notes that attempts to call a turn in the underperformance of value have been going on for years. And so far, all have been false starts.

But it is now impossible to ignore the difference in returns these moves have generated, with the ratio between them exceeding prior multiyear extremes.

Over the past three years, value stocks have underperformed growth stocks by more than 37% — the most negative spread in years and approaching one of the most extreme levels since 1928.

Goepfert riffed his database to determine how the ratio between value and growth did after the 3-year spread reached this degree. Turns out it was a good sign for value … not so much for growth.

The ratio between them narrowed in the following months, with only one exception when looking over the next two years. This was not a short-term phenomenon.

The absolute performance of value stocks was impressive, Goepfert discovered. They rose over the next one, two and three years every time with highly positive returns: By an average of +25.7% in the following year, 47.3% over the following two years and 55.9% over three years, with gains every time.

Meanwhile, growth stocks only rose 19.7% in the following year (which is still very good), +11.1% over the following two years (not as great) and 27.6% over three years (meh).

As for the S&P 500 itself, next-year returns were 15.6%, two-year returns were 16.2% and three-year returns were 21.6%.

Some of the biggest constituents of the iShares Value ETF are AT&T (T), Intel (INTC), IBM (IBM), Bank of America (BAC), Citigroup (C), Chevron (CVX), Pfizer (PFE) and General Motors (GM).

The bottom line?

It looks like a major long-term mean reversion is getting under way. This should be at the front of our minds when picking stocks to own over the next one to three years.

Most people will not catch onto the value-growth switch for quite some time. Smart investors should use this early lead to their advantage.

Best wishes,

Jon D. Markman

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