Value investors finally have something to cheer about.
Their favoured investing style roared back into fashion in recent months after a long, painful period of underperformance. Such shifts in style often persist, so fans of bargain equities may have much more to crow about in the months ahead.
The value school of investing emphasizes buying stocks that are cheap in comparison to fundamentals. It surged from "worst to first" in U.S. markets in 2016, and also rebounded strongly in Canada, according to Bernie Nelson, North American president of Style Research, a London-based firm that tracks how various investing styles are faring in markets around the world.
In contrast, growth investors, who focus on buying companies with rapidly expanding revenues and earnings, endured a generally miserable 2016 across North American markets. Momentum investors, who buy stocks that are already going up on the theory they will continue to rise, also hit a lacklustre patch.
Why are investors swinging back to value? Oddly enough, the fresh affection for beaten-up shares may have to do with a more positive outlook for the global economy.
The new optimism is reflected in bond yields, which surged higher after Donald Trump's election on expectations of faster growth and higher inflation ahead. Purchasing managers' indexes have also painted an encouraging picture of what is unfolding in China and Europe.
Investors tend to bid up whatever quality is scarce in the market at any given point. As prospects for growth heat up, growth stocks become more common and so attract less attention. But value stocks become rarer in such an environment and therefore command more of a premium.
For value investors, that is welcome news indeed. They endured a monumentally bad period in the years after the financial crisis as the market pursued growth and largely forgot about the merits of cheapness. Last year's results provide value hunters with hope that a big swing back may be in the offing.
"This isn't just a story about the energy sector or materials," Mr. Nelson said. His company measures the relative performance of factors within sectors as well as across the market to ensure that it is gauging the impact of investing styles and not just shifts in industry performance.
He cautions that long-term investors have little reason to adjust for what is in or out of fashion in terms of investing styles. However, "this may be an opportunity to get back into value stocks" if you've been avoiding them.
Some of the specific factors that were most strongly associated with good results in 2016 in the Canadian market were an emphasis on dividend yield and low price-to-book values. Outside of such value characteristics, a focus on market beta, a measure of how strongly an individual stock moves in comparison to the overall market, also produced strong results.
In contrast, Canadian investors showed little interest in earnings growth or sales growth. Stocks that shone in those areas produced disappointing returns in 2016.
The question now is how long such trends will continue. History shows that specific investing styles often go on winning or losing streaks that persist for years. However, Mr. Nelson notes, the market can also shift its favoured investing style with little warning.
Today's outlook hinges in large part on whether the prevailing optimism about global economic growth will be borne out by facts. If it is, value stocks are well positioned to continue their strong recent performance. But if Trumponomics or other factors disappoint, so may the market's current love affair with cheap stocks.
Ian McGugan