One of the big market trends in recent months has been the shift from growth to value equities. While US value stocks are still up 16 percent this year vs 11 percent for growth stocks, recent downturn has some investors wondering if value outperformance is over for the time being. However, UBS economists believe that value stocks should reclaim the lead for various reasons.
“The fact that the Fed’s more hawkish tone didn’t force long-term rates up is one of the reasons why growth equities have excelled since the meeting. However, we continue to anticipate that the 10-year Treasury yield will rise to 2% by the end of the year as the global economy normalizes, Congress passes an infrastructure plan, and the Fed begins to taper its bond-buying program. Higher long-term interest rates should increase profitability for financials, the value index’s largest sector, while putting pressure on growth company values.”
“After a roughly 3.5 percent loss last year, the US economy is continuing to recover, and we expect 6.8% growth this year. Value enterprises are more closely linked to economic activity and, as a result, should earn more rewards. As a result, we anticipate value businesses’ earnings to outperform growth companies this year. This earnings strength is expected to wane next year, but profit growth for value companies should still outperform growth companies – an unusual result given that growth companies, by definition, should produce superior profit growth.” “The argument that growth valuations are looking more reasonable appears unwarranted.” The forward price-to-earnings ratio of growth relative to value is close to a 1.8x premium, which is a post-dotcom bubble high. Since 1980, the long-term average – excluding the late-1990s tech boom – has been 1.4x. Simply said, growth company relative valuations are high and susceptible, especially if interest rates rise.”
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