Rotation, rotation, rotation – the switch to value gathers pace

After years of underperformance, value funds are finally starting to catch up with their growth counterparts. 

Optimism about the end of restrictions and a return to ‘normal’ are fuelling an increase in inflation expectations. This is particularly apparent in the States where Treasury yields have risen sharply as the bonds have become less attractive and sold-off. 

On Monday morning the 10-year US Treasury yield hit 1.6%, after the senate passed a $1.9 trillion coronavirus economic relief and stimulus bill over the weekend. The sharp rise suggests that some investors are anticipating an earlier increase in interest rates to head off the inflationary pressures.

Interest rates have been low ever since the global financial crisis in 2008 and this has helped to support long duration assets such as growth stocks whose projected earnings increase the further out you go. It has been a much harsher environment for higher yielding value stocks, but the rotation is now seemingly well underway. 

The times they are a changing 

The pressure for a switch from secular growth businesses like technology to cyclical growth and recovery companies (value) has been building for a while. It was really Pfizer Monday on November ninth that marked the turning point with the approval of the first vaccine setting the economy back on the road to recovery. 

Former stock market darlings like Tesla (NASDAQ:TSLA) have taken a massive hit and at time of writing were almost a third lower than their January high. The same trend can also be seen in the decline of funds like Cathie Wood’s $21.5 billion Ark Innovation ETF (NYSE:ARKK) in the US that invests in these sorts of ‘innovative growth’ companies, as well as Scottish Mortgage (LON:SMT) here in the UK. 

If growth and inflation pick up then investors will be less willing to pay such premium multiples for growth companies, especially if rapid earnings increases can be acquired more cheaply via downtrodden value stocks operating in cyclical sectors like industrials, financials and consumer discretionary. 

Beneficiaries 

There are several value-oriented investment trusts in the UK that could do well if the trend continues, with a prime example being Aberforth Smaller Companies (LON:ASL). Its portfolio of small-cap value stocks has struggled for years, but the shares are up around ten percent in the last three months and the discount has narrowed to four percent.

Temple Bar (LON:TMPL) has recovered strongly since the change of manager last year with a six-month gain of 55%, yet the shares still trade five percent below their NAV. Fidelity Special Values (LON:FSV) has risen 48% over the same period and is now trading close to par value. 

The Edinburgh investment trust (LON:EDIN) is not such a pure value play now that the management has passed to James de Uphaugh of Majedie, but the shares have been steadily rising since the market sell-off last March and they are currently available on a seven percent discount. All four may have much further to run if the rotation continues.