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- By one metric, value stocks have been mired in a bear market for the past two years.
- According to Chris Harvey, the head of equity strategy at Wells Fargo, the investing factor is at an inflection point that will profit those who buy into it early.
- He identified the value stocks best positioned to benefit from an upswing, which are also rated "overweight" by Wells Fargo.
Chris Harvey started 2019 as the titleholder of Wall Street’s biggest bear.
His year-end target for the S&P 500 was the lowest among his peers at major firms until Cantor Fitzgerald churned out a weaker forecast. But Harvey wasn’t bearish per se: He expected a double-digit rally in the S&P 500, just from the lower starting point it plunged to during the fourth quarter.
If the correction somewhat muddled his stock-market views, his latest call for a separate corner of the market is unmistakably bullish. He’s calling the end of a two-year bear market for the value factor, which screens stocks that are trading at low prices relative to their fundamental value.
If the last two years seemed tough for value as defined by Harvey, consider the majority of the post-recession era, when value investors have largely been walloped by high-growth stocks.
"After two years of underperformance and a healthy sell-off in 4Q18, we think the risk/reward for the Value style is much more attractive," Harvey said. "The pendulum is swinging back in Value’s favor — we’re expecting a positive run for the investment style over the next 12 months."
Harvey’s conviction in the value style is driven by what he observes as an inflection point for the factor. Specifically, the median book-to-price ratio of "cheap" and "expensive" stocks rose last year to the highest levels dating since 2011, as the chart below shows. In other words, "expensive" stocks were trading at such a rich premium that Harvey spotted an opportunity for bargain hunters to swoop in on their value counterparts.
Forward earnings are usually the go-to metric for determining how expensive or cheap a stock is. However, Harvey employs book value — a company’s assets less its liabilities — because it’s more stable than earnings over time, especially when the economy is in turmoil.
Beyond the extended spread between cheap and expensive stocks, Harvey observed late last year that macroeconomic conditions were lining up in favor of value. Specifically, he waited for confirmation from three signals before officially advising clients to be overweight value: tightening credit spreads, the Federal Reserve pausing rate hikes, and a flat curve between 2- and 10-year yields.
"These macro trends influence the cost of capital, market risk and ultimately stock multiples especially for Value stocks, which are often debt-heavy and higher risk," he said in a note to clients.
The shaded areas in the chart below highlight moments when investors favored value stocks and reined in the premium that expensive stocks commanded. In Harvey’s view, we’re at another such inflection point.
Shayanne Gal/Business Insider
Previous shifts to value have generally taken 12 months or longer, Harvey said. But there’s reward for investors who buy into the factor early: there was an 11% median 1-year return on Wells Fargo’s multi-factor value model, which combines cash flow yield, price/book and price/sales ratios.
The stocks that emerged at the top of Wells Fargo’s value screen and are rated "outperform" by its analysts were Western Digital, L Brands, FedEx, Nielsen Holdings, and Alliance Data Systems Corp.
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Source: Business Insider – aoyedele@businessinsider.com (Akin Oyedele)