Are value stocks finally back for good?

The Covid-19 vaccine might give value investors the lift they’ve been waiting for, says John Stepek. And the UK is a good hunting ground.

That was quick. In last week’s issue, Jim Mellon told Merryn that investors should buy Lloyds Bank (watch the interview at moneyweek.com/videos). Between that issue coming out on Friday, and Wednesday lunchtime, the share price had risen by 20%. Much as we’d like to claim the credit, the main driver was of course the surging hopes for a vaccine (see page 6). Lloyds was just one of many “value” stocks (companies that look cheap on their “fundamentals”, as measured by various financial ratios) to have rallied sharply on the news that we might soon be able to put the misery of intermittent lockdowns behind us. 

Value stocks have lagged growth stocks since at least March 2009 (when they had a short-lived blip of outperformance) and we’ve heard many a call that “this must be the turn”. So is this just another false alarm? Or did poor Ted Aronson, who closed his $10bn value-focused hedge fund AJO Partners only last month, actually call the bottom of this cycle when he threw in the towel?

The case for value

Why has growth trounced value so badly? One factor is that in a low interest-rate, low inflation, weak-growth world, fast-growing companies which promise lots of future profits – even if they make very little today – are at a premium. If inflation is low, then investors are happy to wait for their money. Given the choice between a reliable but barely-growing income stream today, or the promise of a pot of gold at the end of a rainbow sometime in the future, investors are happy to wait for the pot of gold. So growth stocks (which could be described as “long duration” assets – see below) do well. But if inflation picks up, it becomes riskier to wait, and cash-generative value looks more appealing.

So if we’re seeing a turnaround now, it’s because the vaccine news means markets expect economies to open up faster, which means better economic growth, and potentially higher interest rates and inflation to go along with it. Does that seem a reasonable bet? We’d argue that it does. If anything can generate inflation, then huge pent-up demand combined with free-spending governments is surely it. So what should you invest in? The UK is a good option for value. Despite the recent surge in airlines, banks and oil stocks, there’s plenty of room for more. We looked closely at the value-focused Law Debenture (LSE: LWDB) investment trust in last week’s issue and we’re very glad we kept it in our portfolio. If you prefer pure passive, a plain old FTSE 100 tracker will give plenty of exposure to value. And if we’re wrong? Hang on to your holding of Scottish Mortgage (LSE: SMT), just in case – but think about rebalancing.  

I wish I knew what duration was, but I’m too embarrassed to ask

“Duration” is a measure of risk that usually relates to bonds. It describes how sensitive a given bond is to movements in interest rates. Think of the relationship between bond prices and interest rates as being like a seesaw: when one side (interest rates) goes up, the other (in this case, bond prices) goes down. 

Duration (you can find the measure in the fact sheet of most bond funds) tells you the expected percentage change in a bond’s price in response to a one percentage point (100 basis points) change in interest rates. The higher the duration, the higher the bond’s “interest-rate risk” – that is, the larger the change in price for any given change in rates. This is also known as “modified” duration. 

Duration can also refer to the weighted average length of time (in years) it will take to recoup the price paid for a bond in the form of income from its coupons (interest payments) and the return of the original capital. So if a bond has a duration of ten years, that means you have to hold it for ten years to recoup the original purchase price (this is also known as “Macaulay duration”). In practice, both measures of duration return very similar values. So in the above example, the duration value of ten also indicates that a single percentage point rise in interest rates would cause the bond price to fall by 10%. 

As a rough guide, the duration of a bond increases along with its maturity – so the longer a bond has to go until it repays its face value, the longer its duration. Also, the lower the yield on the bond, the higher its duration – the longer it takes for you to get paid back. All else being equal, a high-duration bond is riskier (more volatile) than a low-duration bond. 

When applied to other assets such as equities (as above), a “long duration” asset refers to the fact that the payback period is lengthy (it takes a while to earn your original investment back) and thus the asset is sensitive to movements in interest rates.

Recommended

Changpeng Zhao: Binance founder undaunted by the crypto winter
Bitcoin & crypto

Changpeng Zhao: Binance founder undaunted by the crypto winter

Changpeng Zhao, the founder of controversial cryptocurrency exchange Binance, has been severely battered by carnage in the sector. But the future is b…
3 Jul 2022
Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
Just how powerful is artificial intelligence becoming?
Tech stocks

Just how powerful is artificial intelligence becoming?

An uncannily human response from an artificial intelligence program sparked a minor panic last month. But just how powerful are machines getting – and…
2 Jul 2022
Persimmon yields 12.3%, but can you trust the company to deliver?
Share tips

Persimmon yields 12.3%, but can you trust the company to deliver?

With a dividend yield of 12.3%, Persimmon looks like a highly attractive prospect for income investors. But that sort of yield can also indicate compa…
1 Jul 2022

Most Popular

UK house prices are definitely cooling off – but are they heading for a fall?
House prices

UK house prices are definitely cooling off – but are they heading for a fall?

UK house prices hit a fresh high in June, but as interest rates start to rise, the market is cooling John Stepek assesses just how much of an effect h…
30 Jun 2022
How to invest in copper, the most important metal in the world
Industrial metals

How to invest in copper, the most important metal in the world

As the world looks to electrify and try to move away from fossil fuels, copper looks set to be the biggest beneficiary. But how can you invest? Rupert…
30 Jun 2022
Don’t try to time the bottom – start buying good companies now
Investment strategy

Don’t try to time the bottom – start buying good companies now

Markets are having a rough time, so you may be tempted to wait to try to call the bottom and pick up some bargains. But that would be a mistake, says …
1 Jul 2022