Value Stocks Show Signs of Awakening

Value stocks have underperformed for years. But things may be changing. Cheaper stocks have shown signs of awakening recently, and several market forces could tip the scales in favor of value after a prolonged growth surge.

It’s been a tough decade for investors who focus on attractively valued stocks with unappreciated recovery potential. Global value stocks have underperformed growth stocks for most of the past decade. In the last two years, this trend has been fueled by the rising popularity of the high-growth FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) in the US.

Shift Appears in Third Quarter

But signs of life for value have recently appeared. In the third quarter, value stocks in emerging markets beat growth stocks by 8.8%, while value stocks in Japan also outperformed. And as stocks fell sharply in October, the MSCI World Value Index declined by 4.8%, outperforming the MSCI World Index by nearly 4% (Display, left). Value stocks also outperformed growth stocks in October across regions (Display, right).

It’s too soon to say whether the recent trend is the start of a bigger shift back toward value. But there are some good reasons to believe that value’s long, dark winter may be coming to an end.

1. Rising rates are usually good for value—When interest rates rise, valuations of growth stocks tend to decline more than those of value stocks. It’s simple math: a rising interest rate pushes up the discount rate that investors apply to future cash flows. That can hurt growth stocks, which derive most of their value from long-term profit growth but may not generate much cash today. In contrast, value stocks typically have lower long-term growth but stronger short-term cash flows, meaning that a higher discount rate typically has a lower impact on their valuation. So with US interest rates rising from historic lows, the table may be set for a real value rebound.