by Tajinder Dhillon.
News of a potential vaccine last week provided a glimpse of hope that the world can return to some level of normalcy in 2021. The announcement from Pfizer on November 9th sent the Russell 1000 to a new all-time high of 2,000.69 on November 13th.
Markets saw an aggressive rotation into value stocks. The Russell 1000 Value index saw a 5.6% gain last week, in comparison to a -1.3% loss for the Russell 1000 Growth index. This resulted in the value index outperforming the growth index by 6.9 percentage points for the week ending November 13th.
Using Refinitiv Datastream, we look back at data since 1980 and observe a remarkable statistic. The last time the Russell 1000 Value index outperformed the Russell 1000 Growth index by more than 6.9 percentage points in a single week was during the Dot-Com Bubble of 2000. For those historians who are interested, value declined 1.1% for the week ending November 10th, 2000, while growth declined by 8.7%.
The rotation into value appeared before the news of a vaccine as demonstrated in our StarMine Monthly Performance Report. This report is updated on a monthly basis and provides factor performance across multiple regions and countries. Value factors performed strongly in October. The StarMine Relative Value (RV) and, in most regions, Intrinsic Value (IV) were among the top performing factors during the month in every major region as shown in Exhibit 1. RV and IV achieved a decile spread of 8.9% and 5.5% in the U.S. during October. This compares to a decile spread of 2.1% and -9.2% in the U.S. for momentum factors Analyst Revision Model and Price Momentum.
Exhibit 1: What Worked Last Month – StarMine Monthly Performance Report
The rotation into value will be cheered amongst disciples of Warren Buffett. Whether this trend continues will remain to be seen. However, Exhibit 2 will serve as a handy reference point for investors. Using the S&P 500 Value index, we look at forward metrics including P/E, Price/Book, Price/Sales, and Price/Cash Flow to assess whether stocks look cheap or expensive.
On aggregate, the picture for value looks encouraging with valuation levels trading close to long-term averages. The forward P/E for the S&P 500 Value index is currently 15.8x in comparison to the 10-year average of 13.8x, representing a reasonable 14.5% premium. If we compare this to the S&P 500 Growth index, the forward P/E trades at 26.8x in comparison to a long-term average of 18.0x, resulting in a rich premium of 48.4%.
Exhibit 2: S&P 500 Value Index – Valuation Metrics
The S&P 500 Value index also looks attractive on a Price/Book basis, which is an important metric for Financials. The financials sector has the largest weight in the Russell 1000 Value Index as shown later in Exhibit 2. The forward price to book trades at 1.94x compared to a long-term average of 1.77x, resulting in a 9.6% premium.
Price to Sales for the S&P 500 Value index trades at 1.4x compared to a long-term average of 1.2x. This compares to 4.3x for the S&P 500 growth index. Finally, Price to Cash Flow per Share for the S&P 500 Value index trades at 10.2x compared to a long-term average of 8.6x.
Looking back to the Russell 1000 Value index, we look at the composition of the index to determine which sectors have the largest sector bias. In Exhibit 3, we use Refinitiv Datastream to determine that Financials (19.1%) has the largest weight in the index followed by Health Care (13.9%) and Industrials (13.4%). Energy makes up the smallest component at 4.1%.
For comparison, the top sector bias within the Russell 1000 Growth index is Technology (44.1%) and Consumer Discretionary (15.9%). These sectors contain ‘FAAMG’ stocks including Facebook, Amazon, Apple, Microsoft, and Alphabet which have shown remarkable top-line growth on a consistent basis. Financials on the other hand only has a 2.0% weight in the index while Energy has a weight of 0.1%.
Exhibit 3: Russell 1000 Value Index – Sector Weights
If the trend for value is to persist, investors should keep an eye on earnings growth. 2021 preferred earnings growth for the Russell 1000 index is expected to be 23.7%. While it is unsurprising to see a positive-growth rate in 2021 given the drawdown that occurred in 2020, we do see a positive sign for value-oriented sectors.
Looking at a sector level, Energy and Industrials have the largest expected year-over-year (YoY) growth at 528.5% and 82.2%. Financials YoY growth is also relatively strong at 20.6%. This will be welcome news for a potential cyclical-led recovery. Defensive sectors including Utilities and Consumer Staples have the weakest growth rate at 3.0% and 6.7% respectively.
The Transportation industry group (240.4%) is expected to post the largest YoY earnings growth within the Industrials sector. Within this industry group, Airlines (86.6%) and Road & Rail (94.1%) lead the way with the strongest expected YoY growth. A vaccine could boost growth rates further due to increased travel and cross-country transportation of goods and freight.
Energy will also benefit from increased air travel as more jet fuel will be produced and sold. 2020 saw prices for jet fuel reach a 22-year low. U.S. oil production also dropped to 10.5 million barrels per day from a pre-COVID peak of 13.1 million.
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