Brandes: the power to stay

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The past decade has been difficult for value investors. Prior to the fourth quarter of 2020, value stocks (MSCI World Value) had their longest and most pronounced period of underperformance on record relative to growth stocks (MSCI World Growth). Many have questioned the “death of value investing” and dispatchers have rushed to the exits.

However, “Pfizer Monday” (November 9, 2020, when Pfizer (PFE, financial) and BioNTech (BNTX, Financial) announced the success of its COVID-19 vaccine trial) sparked a change. From that date through September 30, 2021, MSCI World Value outperformed MSCI World Growth by 11% .1 While the rotation was remarkable and understandably encouraging for disciplined value investors, many remained skeptical. We’ve seen this story before, like in the fourth quarter of 2018 and the fourth quarter of 2016, when value stocks outperformed growth. Both times the outperformance turned out to be a false hope and did not last. As such, it was understandable that in the midst of the most recent value rally, a question arose: Is this time different?

Although we cannot predict the future, several factors have led us to believe that the current pro-value cycle is more resilient than previous periods of “false hope”, including:

  1. Potential for economic recovery
  2. Inflation
  3. Valuation deviations from previous high value cycles

Potential for economic recovery

Pfizer on Monday catalyzed hope for a global economic recovery, ushering in a performance regime shift analogous to previous economic recoveries. As the following table illustrates, US value stocks have outperformed the general market in every economic recovery since 1929.

The value led after the last 14 recessions

Relative price performance of the Fama-French Value Factor market universe (high book value relative to market capitalization) versus the S&P 500 during / after US economic recessions

US GDP growth peak at trough

Performance of US Value Equities Against the S&P 500

The stock outperformed the S&P 500

29 August / March 33

78.3%

May ’32 – August ’32

May ’37 / June ’38

27.2%

May ’40 – May ’41

Feb ’45 / Oct ’45

11.1%

Aug ’45 – Nov ’45

Nov ’48 / Oct ’49

29.7%

Mar ’50 – Jan ’51

Jul ’53 / May ’54

21.5%

Dec ’53 – Dec ’54

Aug ’57 / Apr ’58

26.1%

Dec ’57 – Dec ’58

April ’60 / February ’61

9.8%

June ’60 – May ’61

Dec ’69 / Nov ’70

9.0%

Dec ’69 – Aug ’70

Nov ’73 / March ’75

14.7%

Nov ’74 – Nov ’75

January ’80 / Jul ’80

28.3%

Nov ’80 – Nov ’81

Jul ’81 / Nov ’82

16.8%

June ’83 – June ’84

Jul ’90 / March ’91

18.1%

Dec ’91 – June ’92

March ’01 / Nov ’01

10.3%

Oct ’01 – June ’02

Dec ’07 / June ’09

25.9%

February ’09 – April ’10

Source: Bank of America “US Equity Strategy In Pictures,” June 8, 2020. Peaks and troughs in US gross domestic product according to the National Bureau of Economic Research. Performance of the value universe minus performance of the S&P 500 Index. Positive results indicate an outperformance of the stock but do not necessarily indicate a positive absolute performance. The Fama-French Value Factor stock market universe includes companies listed on the NYSE, AMEX and NASDAQ. High Book Value to Market Cap is the top 30% of the universe based on Net Book Value to Market Cap. The relative performance shown in the middle column was achieved during the respective period in the right column. All performance periods begin / end on the last day of the month (e.g. May 31, 1932 – August 31, 1932, etc.). Past performance is no guarantee of future results. You cannot invest directly in an index.

Coming out of this recession, global economic growth in 2021 is expected to experience its highest post-recession pace in 80 years.2 Since value stocks tend to be economically sensitive, their earnings are expected to increase significantly, while trading at what we consider an attractive valuation level (see chart below). This means that investors may feel less inclined to pay a premium to pursue profit growth potential, further increasing the value potential, in our view.

Consensus More attractive earnings and valuations for the MSCI ACWI Value compared to the MSCI ACWI Growth

AS AT 09/30/21. Source: MSCI via FactSet. EPS: Earnings per share. P / E: Price / Benefits. History of the forward P / E decile represented by the period from June 30, 2003 to September 30, 2021.

Inflation

Global monetary and fiscal stimulus have been significant over the past 18 months, eclipsing those of the global financial crisis. In the United States, M2 money supply, considered one of the future indicators of inflation, increased by 24% year-on-year as of March 31, 2021, almost double that observed during the financial crisis3. In Europe, the European Central Bank has withheld its aggressive monetary stimulus package to support the economy.4

Stimulus and quantitative easing of this magnitude have generally led to inflation, and we are now seeing signs of it in global markets. The 10-year yield has risen since the start of the year and 10-year bond market inflation expectations briefly exceeded 2.5% in mid-May, close to their highest level in a decade. 5 We believe that potentially higher inflation is another possible catalyst for value stocks. As the following graph shows, value had been among the top performers asset classes in times of rising inflation.

Asset class returns during 12 periods of inflation since 1940

Large cap and value stocks performed best

Returns during

Value

Growth

Big

Small

S&P 500

LT Cash

Gold

Inflation periods

Obligations

% Positive

83%

75%

75%

67%

67%

75%

58%

% Outperform the S&P 500

92%

50%

83%

58%

n / A

50%

58%

Average yield

9.2%

2.6%

5.9%

3.8%

2.0%

3.3%

3.9%

12 CPI-based inflation periods: 02/29/40-5 / 31/42, 6/30 / 44-33 / 31/47, 6/30 / 44-33 / 31/47, 7/31 / 50-7 / 31/53, 9/30 / 55–3 / 31/57, 9/30 / 60–2 / 29/64, 1/31 / 66–11 / 30/70, 1/31/73 –2/28 / 75, 30/11/77 to 30/6/80, 30/6/83 to 31/5/84, 28/02/87 to 28/2/91, 30/11/03 to 30 / 09/06, 31/10/10 to 31/01/12.

Source: Bank of America “The Thundering Word” March 11, 2021, based on data from Bloomberg, Dartmouth University Data Library, FactSet, BoFA US Equity & Quant Strategy. Inflation based on core CPI since 1958 and CPI since 1937. Value and growth based on Fama-French High Book / Price and Low Book / Price factors. Long-term Treasury bonds based on the Ibbotson 15+ Maturity Government Bond index. Small and Large size based on Fama-French Small and Big factors.

Valuation deviations from previous high value cycles

Just as the last growth-oriented environment was the longest and most pronounced in favor of growth stocks, it was preceded by the longest and most pronounced value-oriented environment.

Longest and most pronounced value underperformance period

MSCI World Value / Growth Cycles – Indexed relative return (100)

1458553799034765312.png

DECEMBER 31, 1974 TO SEPTEMBER 30, 2021; RELATIVE RETURN OF THE MSCI GLOBAL VALUE INDEX COMPARED WITH THE MSCI GLOBAL GROWTH INDEX (100 INDICES AT THE START OF EACH RIDGE TO CREAM) | The data is indexed at a common starting point at the start of each relative performance cycle to facilitate comparison of numbers of different magnitudes. Source: MSCI via FactSet. It is possible that one index will outperform another while experiencing negative absolute performance. The performance of the index does not reflect the performance of Brandes’ investments.

A common trait between the current value cycle and those of the past? The evaluation is spread out. Prior to the current value cycle (as of September 30, 2020), MSCI World Value has traded at extremely high haircuts (100th or 99th percentile from historical) at MSCI World Growth based on metrics such as the price-to-earnings and price-to-cash flow ratio. The last time valuation spreads were this wide was during the tech bubble of the late 1990s, which was then followed by the strongest value cycle on record (see chart above ). Before that, the only other time in the past 70 years that we saw this level of valuation dispersion was during the Nifty Fifty of the late 1960s and early 1970s, after which the stock experienced multi-year outperformance. compared to growth.

Even after their strong returns over the past eight months, value stocks continue to trade at significant discount levels (first decile from historical) relative to growth stocks, which tells us that it may still be room for the current race in value.

Relative valuation of global value stocks

Assessment against growth stocks against history

14585538000985116672.png

RELATIVE VALUE BASED ON VARIOUS FUNDAMENTAL RATIOS, DECEMBER 31, 1974 TO SEPTEMBER 30, 2021 * | Source: MSCI via FactSet. * Forward P / E data starts 06/30/2003, EV / sales starts 03/31/2000, EV / EBITDA starts 03/31/2000. For each fundamental ratio (P / B-Price / Book, P / E-Price / Profits, P / CF-Price / Cash Flow, Forward P / E-Forward Price / Profits, EV / Sales-Value / Sales of the company, EV / EBITDA-Enterprise Value / Earnings Before Interest, Taxes, Depreciation and Amortization), we calculate the average ratio of the MSCI World Value index and divide it by the average ratio of the MSCI World Growth index to determine the valuation relative.

Is this value-driven environment sustainable? This question cannot be answered with certainty, but we believe that the main catalysts we have discussed, combined with a litany of others (for example, potentially stricter regulations for large-cap tech companies, which constitute a important part of many growth indices; value stocks becoming dynamic stocks, which could give new impetus to the recovery in value) gives us more confidence in the sustainability of the value executed this time around.

  1. Source: MSCI via FactSet from 11/08/2020 to 09/30/2021.
  2. Source: The World Bank; “Global economic outlook,»Published in June 2021.
  3. Source: Federal Reserve Statistical Publication H.6, June 22, 2021; by comparing the evolution of M2’s supply between the period from March 2020 to March 2021 and the period from December 2007 to June 2009. M2’s money supply includes M1 (i.e. cash and check deposits) and readily convertible quasi-money such as savings deposits and money market securities.
  4. Source: The Wall Street Journal, “As Covid-19 Vaccines Lag, Europe Keeps Cheap Money Flowing,” published 04/22/21.
  5. Source: US Department of the Treasury as of 05/31/201 (10-year Treasury yield); Federal Reserve Bank of St. Louis via FRED Economic Data as of 6/30/21 (10-year equilibrium daily inflation rate).

Past performance is no guarantee of future results. It is not possible to invest directly in an index. The declaration and payment of shareholders’ dividends is at the sole discretion of the issuer and may be changed at any time.


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