Value isn’t dead: understand how value equities typically act during normal market cycles The future looked bright for value equities in the first months of 2021. Value shares – those of typically economically sensitive companies with higher credit risks than growth firms – appeared to be on the precipice of a years-long rebound. By mid-May 2021, growth shares resumed their leadership and many investors found themselves wondering what happened to the promising value rally. During the second quarter, growth stocks trounced value, 10.9% to 4.7%.¹ Indeed, since the value countertrend’s zenith on 13 May, growth is up 9.3% while value barely rounded to 0.1%.²
“Value isn’t dead,” says Ken Fisher, founder and co-chief investment officer of Fisher Investments. “But the 2020 bear market’s peculiarities make a near-term comeback unlikely.”
To understand style leadership changes between value and growth, Fisher Investments UK believes it’s best to understand how value equities typically act during normal market cycles, and then compare to the lightning-fast bear market of 2020. Only then does an investor’s path forward become clear. The dynamics of value shares and market cycles
Value equities often lead early in new bull markets because they tend to fall the most during a bear market – a fundamentally driven downturn of 20% or more. Subsequently, value shares frequently “bounce” the most during the following recovery. This process begins in the waning period of a bull market.
Value companies are often smaller. They tend to be more economically sensitive and carry higher debt loads than larger, growth-oriented companies. This reliance on lenders can set the market-cycle trajectory for value companies. “Typically,” Ken Fisher explains, “as expansions mature, central banks fight inflation by tightening credit – but overshoot – lifting short-term rates well above long rates, inverting yield curves. Value shares typically plunge as a bear market sets in because these companies frequently carry higher credit risks. Banks – which borrow short-term, lend long-term and pocket the spread as profit – lose incentive to lend. Stocks pre-price that lending contraction and from that a bear market begins.”
As a typical bear market takes hold, investors look at value companies’ debt load and fret about their ability to weather the downturn. Consequently, investors tend to disproportionately sell off value shares relative to what economic conditions would warrant. Once a new bull market begins, those fears often prove overly pessimistic. This overcompensation drives value shares to rebound more than other categories as bankruptcy concerns fade and stocks price in a brighter future ahead. Expectations of improved credit availability disproportionately benefit cyclical and often less creditworthy firms, which also helps boost value shares. Value’s recent countertrend
Value often leads growth out of a typical bear market; however, 2020’s bear market was far from typical. “Value needs bear markets’ archetypal long, slow grind downhill, culminating in late-stage panic,” Ken Fisher says. “Last year’s bear market barely lasted a month – too short to reset the cycle.”
According to Fisher, this swift, sharp downturn had more in common with a typical bull-market correction: a short, fear-driven market drop of about 10% to 20%. After corrections, category leaders (growth, in this case) before the drop often resume leadership during the recovery. While the 2020 downturn was a bear market by magnitude, it was correction-like in duration. The swiftness of the downturn and its switch to recovery also means that the big expected bear-market lending contraction never came. That means the typical credit boost also didn’t occur to bolster value companies. Rather, market conditions of a late-cycle bull market continue to favour large growth companies. Pay attention to liquidity when positioning in this late-cycle bull market
Understanding the drivers of value’s recent counter-trend reversal gives investors a hint at future portfolio positioning between value and growth. Ken Fisher continues to sound a note of caution about value equities in the current late-cycle bull market for one main reason: liquidity. “I got my launch in investing, doing small value in the 1970s and 1980s,” Fisher explains. “And I know from my own long-distant past decades’ successes and failures that value companies’ shares get very illiquid and hard-to-get-out-of-early in bear markets when banks cut credit to them.”
Value stocks are frequently smaller, lower quality and less liquid. Small and illiquid can be detrimental to investors when a more typical bear market arrives. Illiquidity contributes to value’s market-lagging effect during bear markets, potentially compounding in late bear markets as margin calls and other urgent cash needs force panic selling. Moreover, value stocks could impede your ability to go defensive during […]
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