The past five years have seen the momentum investment style – buying stocks with the strongest recent price appreciation – outperform valuation-conscious investing strategies by such a large margin that “The death of value” columns had become ubiquitous in financial media.
That all changed at the end of August. September has seen such an abrupt change in trend that Steen Jakobsen, chief economist for Denmark-based Saxo Bank, described it as an “equity earthquake.” From seemingly out of nowhere, value stocks are surging while the much more popular momentum stocks, which include the vaunted FAANG (Facebook Inc., Amazon.com Inc., Apple Inc., Netflix Inc., and Alphabet Inc.'s Google) and domestic favourite Shopify Inc., are falling back.
The relative performance of different investing strategies is best illustrated with factor-based exchange-traded funds. In this case, we’ll use the iShares Edge MSCI USA Value Factor ETF (VLUE) to measure value stock returns and the iShares Edge MSCI USA Momentum Factor ETF (MTUM) to gauge momentum stock returns.
Momentum stock investors have been clear winners over the past five years. An investment of US$1,000 in the momentum ETF in 2014 would have generated a profit of US$851, well above the value ETF’s US$320 appreciation.
So far in September, however, the value ETF has climbed 7.3 per cent while momentum stocks are marginally lower. George Pearkes, macro strategist for Bespoke Investment Group, was among the first to recognize the surge in value stocks. Mr. Pearkes noted that the Sept. 9 trading session marked the biggest one-day outperformance of value over momentum in the history of the ETFs mentioned above.
The Bespoke strategist also recognized that this change in performance trend is associated with September’s other big market surprise – rising bond yields.
Value vs. momentum:
A sharp change in trend
iShares Edge MSCI USA Value
Factor ETF/iShares Edge MSCI
USA Momentum Factor ETF
U.S. 10Y bond
yield (inverted)
1.60
1.0
1.55
1.5
1.50
1.45
2.0
1.40
2.5
1.35
1.30
3.0
1.25
S
O
N
D
J
F
M
A
M
J
J
A
S
2018
2019
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: SCOTT BARLOW; BLOOMBERG
Value vs. momentum: A sharp change in trend
U.S. 10Y bond yield
(inverted)
iShares Edge MSCI USA Value
Factor ETF/iShares Edge MSCI
USA Momentum Factor ETF
1.60
1.0
1.55
1.5
1.50
1.45
2.0
1.40
2.5
1.35
1.30
3.0
1.25
J
S
O
N
D
J
F
M
A
M
J
A
S
2018
2019
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: SCOTT BARLOW; BLOOMBERG
Value vs. momentum: A sharp change in trend
iShares Edge MSCI USA Value
Factor ETF/iShares Edge MSCI
USA Momentum Factor ETF
U.S. 10-year bond yield
(inverted)
1.60
1.0
1.55
1.5
1.50
1.45
2.0
1.40
2.5
1.35
1.30
3.0
1.25
S
O
N
D
J
F
M
A
M
J
J
A
S
2018
2019
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: SCOTT BARLOW; BLOOMBERG
The accompanying chart compares the relative returns of momentum and value stocks with the U.S. 10-year bond yield. (Note that the bond yield is plotted inversely to better show the trend). The purple line represents the price of the momentum ETF divided by the price of the value ETF. A rising line indicates momentum is outperforming value – the actual number on the left y-axis doesn’t matter, we’re just looking at the directional trend.
The outperformance of momentum stocks is closely associated with falling bond yields, which is the case for the majority of the chart until Aug. 27. The violence of the change in trend is apparent in the rapidly falling purple line after that point. Value stocks began outperforming as bond yields began rising.
Rising bond yields indicate higher economic growth expectations and this is good news for value stocks. For much of 2019, global economic data were deteriorating and this made companies with strong profit growth scarce. Investors increasingly shifted assets to the few companies that were able to generate profits – many in the technology sector – and this process spurted the rally in momentum stocks.
The higher growth expectations implied by rising bond yields suggest that the number of companies able to grow profits is expected to increase. In this “rising tide lifts most boats” situation, investors can outperform by owning the most attractively valued stocks where earnings growth is improving. In other words, value stocks.
The trend toward value stocks is a recent phenomenon, but Goldman Sachs strategist Ben Snider believes it represents an important watershed event. In a Thursday research report, Mr. Snider wrote: “Sharp momentum drawdowns similar to the one that has taken place in the last two weeks usually mark the end of the momentum rallies rather than tactical buying opportunities.”
Although Shopify was mentioned above, applying this analysis to Canadian equity markets is not straightforward because of the dominance of bank and commodity stocks in the S&P/TSX Composite Index. The new trend toward value is likely constructive for domestic bank stocks, which are trading at attractive valuations relative to history, but the banks are so widely held in Canada that they are almost always in the “growth at a reasonable price” category rather than pure value.
The commodity stocks, which are also attractively valued in many cases, are often driven by resource prices, which can support or conflict with a value-versus-growth market trend.
I don’t want to suggest investors make wholesale changes to their portfolios based on a trend that’s been in place for less than three weeks – even if Goldman Sachs is leaning that way. On the other hand, I’m a bit overwhelmed by the amount of attention the market’s switch to a value focus is getting among strategists, portfolio managers and financial media, and I’m inclined to take it seriously.
Scott Barlow