Samantha Gleave

Vaccine rally highlights value opportunity

Samantha Gleave

The vaccine announcements by BioNTech/Pfizer and Moderna led to sharp gains by stockmarkets, but a closer look shows it was value stocks that enjoyed the best of the rally. Viewed through the framework of the Cashflow Solution process, we find some encouraging signs that value could now be set for a sustained period of good performance.


Value’s underperformance over the last few years has been well documented. We have highlighted it in several blogs, most recently in September, when we explored whether cash flow should be viewed as a key component of a modern, updated appraisal of value. However, as news of a potential vaccine broke, there was a significant factor rotation in value’s favour.


Value vs growth


It was not only news of a vaccine that provided extra impetus to the value investing case: the US presidential election results also provided a boost. For us, one of the key implications of a new Democrat President is the potential for a significant infrastructure stimulus programme to be announced. This could be positive for sectors such as industrials, materials, consumer discretionary and – with a potential knock-on impact on bond yields – financials, which appear to be the core of the value cohort.


Furthermore, we have for some time been highlighting the warning signals apparent in momentum – a theme which is largely dominated by growth-style tech companies. The vaccine announcement led to the biggest one-day momentum crash in history but, given the high valuations and volatility the theme is experiencing, we think there could be further downside.


Despite optimism about a vaccine, we are clearly not out of the woods yet and the latest rounds of lockdown measures will further curtail the economic recovery in the fourth quarter. It is still too early to say whether this recent rotation into value will be the start of an extended period of outperformance, but we certainly see positive signs.


First, the spate of third quarter trading updates has given us reasons to be optimistic. A number of stocks reported better-than-expected recent volume and pricing trends. For example, Pandora, the Swedish jewellery retailer, announced double digit like-for-like growth in several key markets and commented that trading in October was up 8%. In the autos sector, Peugeot saw better-than-expected third quarter revenue driven by improving volumes and positive pricing. UK housebuilder Vistry published a robust trading update including strong forwards sales trends for the quarter ended September 2020 and commented that pre-tax profits were forecast to be at the top end of the range of market forecasts.


The latest lockdowns may negatively impact fourth quarter trading, but we would expect these positive trends to re-emerge once the restrictions are eased.


While these qualitative observations provide some anecdotal support for investing in value stocks, our investment decision-making is always based on rigorous application of the Cashflow Solution investment process. The indicators that feed into this investment process also continue to point to a compelling opportunity for value stocks.


By our measures, there is a wide spread in share valuations between value companies, which tend to have high cash flow yields because their share prices have been depressed, and growth companies, where share prices are elevated but cash flow yields are low.


Value stocks have excellent backward-looking cash flow yields as a result of strong historic cash generation combined with share prices that have been among the worst affected by the pandemic. While many of these companies are indeed enduring trading difficulties currently, we expect cash flow to revert to normal levels as economies recover from the pandemic. This should lead to a value rally that would close the large gap that currently exists to more highly rated growth stocks.


Valuation Spreads


Our equally weighted market valuation measure shows that European markets are inexpensive, while our indicators of aggressive corporate behaviour are at low levels, suggesting that company managers are being cautious regarding capital expenditure. This all points to a positive equity market outlook.


Earlier this year, we highlighted the conclusions of our annual review of stocks. This included an increased tilt away from growth and momentum styles and towards value. More recently, we have again reallocated some excess cash to stocks that are in the top quintile of our core cash flow screen and also possess attractive contrarian value and low crowding scores (a measure of how popular a stock is with investors.) Very cheap cyclical stocks have been prominent in these selections, across sectors such as consumer discretionary (e.g. Carnival in travel & leisure), financials (e.g. Bank of Ireland and BNP Paribas) and energy (e.g. BW Offshore and BP). Valuation spreads remain well above historic average levels in these sectors, highlighting an attractive investment opportunity in our view.


Of course, it is difficult to predict the exact timing and magnitude of a sustained rally in value. The near-term economic outlook is very uncertain, which will undoubtedly contribute to bumps in the road for value in the form of risk-off days. However, recent developments (both medical and political/economic) should not be ignored. Has a new value-led market regime finally started to emerge?


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Liontrust Insights


Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Cashflow Solution team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Liontrust European Growth Fund holds a concentrated portfolio of stocks, if the price of one of these stocks should move significantly, this may have a notable effect on the value of the respective portfolio. The Liontrust Global Income Fund's expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Friday, November 20, 2020, 10:59 AM