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Why Value Stocks are Still a Bargain

David Hicks

A few months ago, I wrote about how recessions change market leadership, causing a so-called rotation. In other words, the types of investments that are in favor at the beginning of a recession tend to move out of favor after the recession ends.

In September 2020, the top dogs of the U.S. stock market—a small collection of growth-oriented and technology stocks that have been star performers for the last few years—saw their fortunes shift as a more varied collection of economically-sensitive, value-oriented stocks (which are considered to be cheap and are trading for less than they are worth) began to creep into favor. Global interest rates began to rise, which pushed inflation expectations higher. This has inspired investors to look beyond those expensive, large U.S. tech stocks to a broader range of assets, especially international, emerging-market, small-cap, and value-oriented stocks. Inflation-related assets (like commodities and Treasury inflation-protected securities, or TIPS) have also advanced.

So why have markets begun to rotate recently?

Value Stocks Remain a Bargain

Getting great prices on stocks isn’t always a catalyst for performance, but many experts think they are an essential consideration.

Long-term relationships between a company’s stock price and its fundamentals (the data that show a company’s financial health, such as profitability and cash flow) typically hold up for good reason and should not vary by large degrees for extended periods. This is because a stock’s price and its returns tend to revert back to their historical averages over time.

COVID-19 Vaccines Support Economic Recovery

A wider rollout of COVID-19 vaccines and a resumption of economic activity should help sustain the gradual strengthening of market sentiment in favor of value and cyclical stocks. As more Americans receive vaccines and vaccination rollout speed picks up, it’s likely that government-imposed restrictions will be loosened.

Gimme That Stimmy

Global monetary and fiscal policies have experienced an unprecedented level of support, especially in the U.S. Generous stimulus packages have motivated consumers to spend more, which is great news since consumer spending drives about 70% of total U.S. economic activity.

Although the yields (or interest paid) on longer-term U.S. Treasury securities have ratcheted up in response, it remains close to the lower end of historical levels. The Federal Reserve has hinted that short-term interest rates should remain low until 2023. If the U.S. economy continues to rebound in the next six months, longer-term interest rates may rise as well.

Don’t Chase the Highs

Have you ever been tempted to chase the next big thing when the market starts to rotate? It’s a common impulse to be sure. But that doesn’t mean you should give in to it. If you’d like a second opinion on your portfolio, our advisors can help. Click here to set up a free, no-obligation meeting.

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