Are value stocks looking up?
While the US economy is expected to experience strong growth in 2021, stock valuations appear high. Nonetheless, the outlook is positive for the cyclical finance and energy sectors, in addition to paying dividends of impressive value. According to T. Rowe Price’s article, “What’s Next for Value Stocks,” by John D. Linehan, Portfolio Manager, Equity Income Fund, the focus will remain on tracking underrated companies with intrinsic value. .
As noted, there has been an accelerated rotation from growth stocks to value stocks during the first quarter of 2021. However, this becomes a question of sustainability when you consider the recovery of cyclical industries, revealing the question of find out if value stocks will have more room to develop.
According to Linehan, “a lot depends on the success of the efforts to bring the coronavirus pandemic under control.”
This is not surprising, as the number of immunization programs and the significant fiscal stimulus injected into the US economy have been encouraging. Additional spending on infrastructure in the coming years is also a good way to stimulate strong economic growth. Between the push up and T. Rowe Price’s opinion on stock valuations, it looks like the market as a whole may generate modest returns in the coming quarters.
Linehan shifts here, stating: “Nonetheless, we find opportunities in certain cyclical sectors, such as financial services and energy, where we are drawn to quality companies that could benefit from a continued recovery in the US economy. , but which also present what we consider to be a favorable valuation profile.
What will come from the rally in value
In the first quarter of 2021, large-cap value stocks on the Russell 1000 Index outperformed their growth counterparts and the broader market. it was a way to take advantage of the turnaround in the pandemic-induced market upheavals that made up such a large part of the 2020 investment landscape. Given this development, from the secular non-rotation rotation, there could be a release. pent-up demand, allowing earnings growth in cyclical industries.
Percentiles of the valuation premium of large-cap growth stocks relative to their value peers.
Given the excesses of the first quarter, the valuation premium remained high at the end of March 2021. With this in mind, this gap could be further reduced by a rotation of growth stocks and expansions of the valuation multiples commanded by value stocks.
This signals the possibility for some cyclical sectors to do well if earnings growth accelerates and multiples recover from the recent squeeze. This is a way of standing out from the larger market and growth stocks, which in turn would set the bar high for expectations that corporate earnings are expected to exceed.
Further, as Linehan pointed out, “in this environment, we see the potential for income-oriented investors to look to dividend-paying stocks.1 due to the low yields available on the bond market.
The way to find new opportunities
Energy and Financials were the best performers on the S&P 500 Index in the first quarter. However, T. Rowe Price believes that these cyclical sectors could still offer attractive risk / reward profiles for discerning value investors. As noted, “Typically during downturns, cyclical stocks experience an increase in their price-to-earnings ratios due to the decline in earnings that accompanies an economic contraction. The past year presented additional challenges based on the disruption caused by the pandemic.
After such low levels, valuations in both sectors are still attractive to T. Rowe Price. It is possible that corporate profits and cash flow may surprise on the upside if economic growth accelerates, interest rates rise, and inflationary pressures develop. Valuation multiples should improve accordingly. Exposure to potential upside catalysts can also come from financials and energy stocks. It would provide some degree of confidence, if the macro tailwinds were heading in a different direction.
In addition, some banks may have the potential to increase their dividends or step up their share buybacks. The risk / return profiles offered by some P&C insurers also arouse good feelings.
The energy sector still faces long-term challenges due to concerns about climate change. However, T. Rowe Price takes a constructive view of the energy sector, as prevailing valuations do not appear to reflect the potential that oil prices could be more favorable in the years to come. When it comes to oil and gas producers, there is a preference for high quality operators with strong balance sheets, competent management teams and lower cost assets.
“We are also finding opportunities outside of cyclical companies, as relative valuations in defensive sectors become more attractive,” the article continues, as many utilities exhibit attractive dividend yields and are positioned to increase their rate bases through capital investments linked to the transition to clean energy.
Linehan concludes: “While we continue to favor cyclical stocks in the current environment, our valuation discipline and in-depth research on sectors and individual companies remain our guides as we seek to take advantage of market dislocations to short term and changes in risk / return profiles. . “
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