If you’re not familiar, value stocks are companies that usually trade at a lower price relative to their fundamentals, such as dividends, earnings, and sales.
For instance, small caps can be considered as value stocks.
Right now, US value stocks look poised to outperform their growth peers, over the next 12 months.
In fact, The Wall Street Journal recently reported that in the past 12 months, the Dow Jones US Value Index beat its Growth Index counterpart 3.8% to 2.1%.
This continued in the third quarter of 2019 – with the Value Index beating the Growth Index by 1%.
And it happened again in the month of September, when the Value Index grew 3.5% more than the Growth Index.
Because of this, value stocks are now experiencing a new wave of optimism from US analysts and fund managers going into 2020.
So, what’s driving this optimism?
Three reasons why US fund managers are calling value stocks a “buy”
#1: Value stocks outperform during the later stages of a business cycle
Historically, growth stocks do better in bull markets, when companies’ earnings are rising. When the economy starts cooling and there is less expected earnings growth, the high valuations of growth stocks get ‘punished’ and they cool off.
On the other hand, value stocks usually do well in early stages in economic recovery and during periods of weak economic growth.
Also value stocks often outperform growth stocks during the latter end of a bull market.
Just consider that during the “Roaring 90s” – a period of fast US economic expansion, growth stocks dramatically outperformed value stocks.
When the economy reversed itself in the new millennium, value outperformed growth until the 2008 Financial Crisis.
When the crisis cooled, the US economy began to expand again. This fuelled massive growth in the stock market – particularly in growth stocks.
But after a 10-year bull-run, there are signs that US growth is slowing. In 2020, US growth is expected to fall to 1.9% from 2.3%. And it’s usually during this low growth environment where value shares outperform again.
#2: Value stocks trade at their most attractive levels since June 2003
Right now, value stocks trade at their most attractive levels since June 2003.
The good news, historically, value stocks have outperformed their growth peers by an average of 6% over the following year, when the valuations widen that much.
#3: Value stocks become attractive investments when the US cuts interest rates
Value stocks also have something else going for them right now: US Interest rate cuts.
This year, the Feds have cut rates three times. Historically, value stocks outperform growth stocks when the rates fall.
Take a look at the chart below…
It shows that after the Feds cut rates, US small caps (value stocks) outperform mid and large caps, over three, six and 12 months.
They average a 12-month return of 27.9% vs large caps average a gain of nearly 15%.
The reason why: Lower rates boosts the US housing market, which constitutes a very large portion of small-cap earnings. More than 30% of small-cap earnings come from housing. Meanwhile, around 12% of earnings in large-cap stocks come from the housing sector.
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So, what’s the best way to invest in US value shares?
The iShares S&P Core Small-Cap ETF (IJR).
This well-established fund is one of the largest and most popular in the US small cap space. It tracks the S&P Small Cap 600, which represents about 3% of the US securities market.
What makes it attractive is the costs to hold this ETF are lower than the Vanguard Small-Cap 600 ETF and the SPDR S&P 600 Small Cap ETF, which tracks the same index.
In 2019, this ETF has returned 17.86%. While impressive, it’s still +15% down from its 2018 highs.
So, if you’re keen, you can buy this ETF from any broker.
See you next week.
Joshua Benton, The South African Investor
P.S. If you’re looking for real value at home, then you need to take a look at these stocks just released by my colleague Francois Joubert.
Francois has identified a certain set of ‘spin off’ companies that could be about to break up the JSE. And if you play it right, you could end up with a windfall of profits – Here’s all the details!