Value stocks drawing attention.
Value stocks lagged growth stocks throughout almost the entirety of the 2010s, but that dynamic started to shift a bit in the second half of 2019. Bank of America analyst Savita Subramanian says this change in leadership from growth to value among U.S. stocks will likely continue for several reasons. Bank of America is projecting S&P 500 earnings per share will increase 8% to $177 in 2020, creating even more compelling buying opportunities among undervalued stocks. Here are nine reasons to buy value stocks in 2020, according to Bank of America.
Profit growth is accelerating.
Subramanian says one of the biggest drivers for value stocks in 2020 will be profit growth. Historically, growth stocks have outperformed value stocks when U.S. profit growth has been decelerating. In periods with accelerating profit growth, value stocks tend to shine. Subramanian says the fourth quarter of 2019 will likely mark the bottom in S&P 500 trailing earnings per share growth and that growth will begin to pick up heading into 2020. Profit growth has been decelerating since the third quarter of 2018, but Bank of America expects it to increase in each quarter of 2020.
Value stocks are under-owned.
Another reason why value stocks could start to gain steam this year is because they have been so neglected by institutional funds. Subramanian says active fund managers currently have near record-high exposure to momentum stocks and are underweight value stocks. Bank of America has already seen money start to flow back into value funds in the second half of 2019, and flows into value-oriented sectors such as financials and energy have also started to rise. If fund managers continue to dial back exposure to momentum stocks, it could serve as a headwind to the technology and consumer discretionary sectors.
Value stocks are cheap.
By definition, value stocks offer investors a compelling valuation. But Subramanian says todayâ€™s value stocks are cheaper than they have been relative to growth stocks since the financial crisis back in 2008. In fact, 2003 and 2008 are the only other times in history the valuation gap between value stocks and growth stocks has been as large as it is today, she says. In those two instances, value stocks outperformed growth stocks by 22% and 69%, respectively, over the following 12 months. Value stocks are historically cheap relative to growth stocks based on forward earnings multiple, price-to-sales and price-to-earnings-to-growth ratio.
Negative correlations between value and growth stocks.
Correlations between value stocks and momentum stocks recently reached their most negative level in history. Subramanian says that large negative correlation suggests unusually high flows and positioning in one factor relative to the other. Recent correlation levels heavily favor value stocks over growth stocks heading into 2020. The negative correlation between growth and momentum stocks recently surpassed its previous low point in 2016. Since 1986, every time the negative correlation between momentum stocks and value stocks dropped below the 20th percentile threshold, value stocks have outperformed growth stocks 77% of the time over the following 250 days.
U.S. is approaching a value cycle.
Based on a number of top-down economic variables, including inflation and credit conditions, Subramanian says the U.S. may be approaching the beginning of a value cycle. Although the U.S. never entered an economic recession in 2019, Subramanian says the economy has been in phase four of Bank of Americaâ€™s macroeconomic cycle for about eight months. Phase four is the â€śdownturn/recessionâ€ť phase of the macroeconomic cycle, and it is typically good for high-quality, low-risk and large-sized stocks. Phase one of the cycle is the â€śrecovery/early cycle,â€ť which is typically good for value, small-sized and high-risk stocks.
Value dispersion near record highs.
Value dispersion is the valuation gap between the cheapest and most expensive stocks in the markets. Subramanian says the value dispersion of the S&P 500 based on forward earnings multiples is near its highest level in history. This large dispersion could be an indicator that stock prices have temporarily disconnected from underlying business fundamentals. Throughout history, when the valuation dispersion has been as high as it currently is or higher, value stocks have outperformed growth stocks over the subsequent 12 months 95% of the time. The average value outperformance during those periods was 24%.
Positive analyst commentary.
Wall Street analysts arenâ€™t perfect, but it never hurts when the consensus opinion among professional stock analysts is bullish. Subramanian says the Bank of America analyst team has been getting more positive on value stocks relative to momentum stocks. Bullish tone among Bank of America analysts on value stocks relative to momentum stocks recently hit its highest level since July 2016, its peak since the financial crisis. In the 12 months following the previous spike in bullish analyst tone, value stocks outperformed momentum stocks by 15%. Bank of America analysts are now equally bullish on growth stocks and value stocks.
Value stock market cap has dropped.
Another way to appreciate the long-term underperformance of value stocks is to look at the median market capitalization among S&P 500 value stocks. Subramanian says the median market cap of S&P 500 components that have the lowest 10% of forward earnings multiples is about 60% of the median market cap of the entire index. Subramanian says that since 1998, any time that median value stock market cap has dropped below 70% of the overall S&P 500, value stocks have outperformed over the following six months two-thirds of the time by an average of 6.5%.
Bullish on financials.
The financial sector is Bank of Americaâ€™s top market sector pick for 2020. Financial stocks have historically been big winners during periods of market rotation from growth to value. Today, the financial sector represents about 25% of the Russell 1,000 Value benchmark, by far the largest weighting of any sector. The S&P 500â€™s overall forward earnings multiple is about 18.2, but the financial sector multiple is just 13.3. Bank of America recently named Citigroup (ticker: C) its top financial sector stock pick for 2020. Citigroup is certainly a value play given its 9.4 forward earnings multiple.
Reasons to buy value stocks in 2020:
Profit growth is accelerating.Value stocks are under-owned.Value stocks are cheap.Negative correlations between value and growth stocks.U.S. is approaching a value cycle.Value dispersion near record highs.Positive analyst commentary.Value stock market cap has dropped. Bullish on financials.