The swing from growth stocks into value has been one of the major market themes in recent months. While US value stocks are still up 16% this year versus 11% for growth, their recent weakness has caused some investors to ask whether this marks the end of value outperformance for now. But economists at UBS think that value stocks should regain the lead for several main reasons.
The outlook for a modest rise in long-term yields by the year-end favors value relative to growth
“Part of the reason growth stocks have outperformed since the Fed meeting is that the more hawkish tone didn’t push up long-term yields. However, we continue to believe that the 10-year Treasury yield will move up to 2% by the year-end as the global economy normalizes further, an infrastructure bill ultimately gets through Congress, and the Fed moves toward tapering its bond-buying. Higher long-term interest rates should boost profits for financials, the largest sector in the value index, and weigh on valuations for growth companies.”
Value stocks perform well in periods of strong economic growth, such as at present
“The US economy is continuing to rebound after last year’s roughly 3.5% contraction, and we forecast economic growth of 6.8% this year. Value companies tend to be more tied to economic activity and should therefore reap outsize benefits. As a result, we expect earnings for value companies to outpace growth companies this year. This earnings strength is likely to moderate next year, but profit growth for value should still rival growth companies – an unusual outcome considering that growth companies, by definition, should produce superior profit growth.”
The high valuations of growth stocks relative to value make them vulnerable
“The argument that growth valuations are looking more reasonable seems unwarranted. The forward price-to-earnings ratio of growth relative to value is at a post-dotcom bubble high, at close to a 1.8x premium. In comparison, the long-term average since 1980 – excluding the late 1990s tech bubble – is 1.4x. Simply stated, relative valuations for growth companies are elevated and look vulnerable, especially if interest rates rise.”