Rotation to Value
November 26, 2020

Rotation to Value

James Rutland, European Equities Fund Manager

The announcement on Monday 9 November that an effective vaccine for COVID-19 could be imminent drove a recovery in some of the so called ‘Value sectors’ in the market.

In fact, it was one of the biggest rotations we have ever witnessed. The key question now is, can this be sustained? To our mind, there are 3 strong drivers why it can:

1.

As equity investors, we expect earnings to lead share prices. What has struck us as peculiar this year is the stubbornness of outperformance of ‘Growth’ vs ‘Value’. There is growing evidence that things for ‘Value’ stocks are not anywhere near as bad as they might seem, particularly on a relative basis where we have seen a more encouraging picture on the earnings outlook. Anecdotally, coming out of 3Q earnings season, we have continued to see reassuring signs of economic momentum, particularly in sectors like Autos. From here, we could argue that the earnings outlook for ‘Value’ sectors has taken a significant movement higher once again. In the short-term, despite the fears, it is unlikely that this second lockdown will have the same economic implications. Firstly, because lockdown measures are not as draconian. 

 

Figure 1
Figure 1

Secondly, corporates and consumers are better equipped to cope with the challenges posed by the restrictions.

Finally, and more importantly, should the vaccine prove to be as effective as suggested, we can be confident that the macro outlook will improve, and this will add further support to the earnings outlook. The industries that have suffered the most so far this year are Travel & Leisure, Oil & Gas, Autos and Banks, and for clear reasons – these are amongst the most economically sensitive sectors. These are the sectors we would expect to lead the recovery.

 

Figure 2
Figure 2
2.

Putting the 2-day move into a longer-term context we still have significant upside potential. This European ‘Value’ vs ‘Momentum’ chart has moved in one direction for a very long time and the policy environment we are now moving into is significantly different to that which has gone before. Central bankers globally are calling for a fiscal response and finally, governments are heeding the call. We touched on some of these points in a recent piece in the context of the US election: The US Election: A European Perspective.

Figure 3
Figure 3
3.

We know positioning is extreme. When ‘Value’ outperforms, many European funds suffer. This is clearly seen below with European active funds positively correlated with ‘Growth’, and negatively correlated with ‘Value’.

Figure 4
Figure 4

With two of the three big uncertainties now taken off the table, one could argue that all the ingredients are there for a more sustainable rotation, particularly considering the extreme relative starting point. The final hurdle is Brexit and we note that even there, despite some of the scarier headlines, the rumours in the press are encouraging in terms of getting a deal. With these hurdles out of the way, we can be optimistic that this rotation into ‘Value’ has duration.

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  • The opinions referenced above are those of the author as of 6 November 2020, unless stated otherwise.

    Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.