A wild market selloff in the latter half of 2018 and an increasingly dovish Federal Reserve are shaping up to be positive factors for the performance of value stocks in 2019. Trading at deep discounts relative to their own history, value stocks like Western Digital Corp., L Brands Inc., FedEx Corp., and Nielsen Holdings PLC, are positioned to outperform this year. “Over the next 12+ months we expect history to repeat itself and Value factors such as cash flow yield, price-to-book, and price-to-sales to perform well,” wrote Wells Fargo analyst Christopher Harvey, according to Barron’s.
4 Big Losers May Become Winners
· Western Digital (WDC): - 42%
· L Brands (LB): - 45%
· FedEx (FDX): - 26%
· Nielsen Holdings (NLSN): - 22%
Source: CNN Money, 1-year performance as of 4pm EST 2/08.
What it Means for Investors
The underperformance of value stocks over the past several years relative to their growth stock counterparts has caused many to wonder when a “value rotation” might finally arrive. Many were expecting the value turnaround to come last year, but the late selloff dashed those expectations. However, it did make the underperforming value stocks even cheaper. Harvey argues that an inflection point for value stocks is now on the near horizon as the valuation gap between the S&P 500’s cheapest stocks and its most expensive ones has not been as wide as it is now since the 2008 financial crisis.
The Fed’s indication that it is holding off on further interest rate hikes and will proceed more slowly with its current rate-hiking cycle is another catalyst for value stocks. Harvey also notes tightening credit spreads and an already-flat yield curve that is starting to steepen as positive indicators. “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 wrote, as per Barron’s.
One of Wells Fargo’s top value picks, FedEx, is actually so cheap right now that some analysts argue that Amazon.com should consider buying the company if the e-commerce behemoth wants to dominate package-delivery service as well. With FedEx currently trading at a forward price-to-earnings ratio (P/E ratio) of 9.85, Loop Capital Markets analyst Anthony Chukumba recently wrote, “Amazon could make an accretive acquisition of the best global network for a fraction of the cost of building it themselves.”
Analysts at JPMorgan confirm that there is indeed an extreme spread in valuation between value and growth stocks, which is just one reason they expect value stocks to explode higher. Also agreeing with Harvey’s thesis that the Fed’s more dovish stance is good for value stocks, the analysts cite the near cycle high of forward-valuation dispersion, the beginning-of-the-year seasonal factor that tends to favour value stocks, and expectations of a weakening U.S. dollar as other reasons to be optimistic.
Looking Ahead
While value stocks are at their cheapest levels in recent years, the market’s recent rally has given growth stocks new life. As long as investors remain optimistic about growth stocks it may take some time for the rotation to value to occur. However, if the rally falters, value stocks may get their chance to thrive.
