One of last year’s hottest quant trades is getting a reboot, even as it misfires in the world’s largest stock market.
So-called value shares — which trade at lower multiples relative to fundamentals — are all the rage again but this time in Asia and, more recently, Europe.
Investors are essentially betting that global interest rates will stay higher for longer without torpedoing economic growth. In Japan, cheap-looking shares have outperformed so-called growth equities by a beefy 17 percentage points on a total return basis, MSCI indexes show. That comes amid growing expectations that the Bank of Japan is closer to ending its historic monetary-easing campaign.
In other parts of Asia, the investing style has won out by 7 percentage points. In Europe, a resurgence this month has put cheap shares in the lead for 2023.
For so-called factor investors who slice and dice shares by how cheap they look, the strategy’s overseas gains are softening the pain from losses over in the US — where an extraordinary AI boom is instead boosting shares touted for their long-term growth promise. On Wall Street, value has trailed growth by 30 percentage points, set for the worst annual performance since the 2020 pandemic crash.
“In this new higher-for-longer rates regime, cheaper stocks should have more chance to outperform, especially if they deliver stronger earnings as they have been doing most recently,” Barclays Plc strategists led by Emmanuel Cau wrote in a note.
While the link between economic trends and quant factors is contentious among specialists, value shares are generally expected to outperform when rates rise along with the economic outlook because they offer near-term cash flows. That’s reflected in the sector leaderboard lately: from Asia to Europe, typically cheaper sectors like energy and financials are beating the market.
‘Amplified Effect’
In Japan in particular, value shares also got a boost after Warren Buffett boosted investments in the country’s trading houses and the stock exchange urged companies with low price-to-book ratios to try to improve valuations.
The rise in value stocks “indicates that the BOJ isn’t going to slow the economy too much or slow things too quickly,” said John Vail, chief global strategist for Nikko Asset Management Co. in Tokyo. “It suggests investors think inflation in Japan and globally will be sustained above normal levels.”
Banks are a good example. Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc., three of Japan’s largest lenders, are each up more than 40% this year on expectations that their margins will finally expand when the BOJ tightens policy.
Other companies have also rallied, including automakers which are likely to benefit as a recovery in supply chains boost production. Toyota Motor Corp., which makes up a tenth of the Japan value index, is up more than 50% this year while Honda Motor Co. surged over 70%. Industrial giant Mitsubishi Corp. jumped almost 80%.
In the country, “inflation is having a very positive effect on earnings,” Vail added. “Because profit margins are so low, price hikes have an amplified effect on the bottom line.”
ECB Boost
In Europe, value stocks lagged their growth counterparts for most of the year before jumping this month, just as the European Central Bank raised rates for a 10th consecutive time last week. Higher borrowing costs have supported lenders — stalwarts of the common bloc’s value universe — while rising oil prices spurred the likes of Shell Plc and BP Plc higher.
All told, the absence of an almighty tech sector is boosting multi-factor strategies outside the US. These systematic portfolios are typically diversified across hundreds of shares picked according to a handful of corporate characteristics like value, which means they tend to fare worse when a few large-caps dominate gains.
The PIMCO RAFI Dynamic Multi-Factor International Equity ETF, which is focused on developed markets except the US, has risen 9% this year. The emerging-market version is up 7% versus 3% for the American equivalent.
“What is at play is not a pure factor effect, but a factor effect plus some things that are specific to the US,” said Olivier Laplenie, head of quant portfolio management at BNP Paribas Asset Management. “And what is specific to the US this year is the performance of some mega-capitalization stocks linked to artificial intelligence.”
Author: Richard Henderson, Justina Lee and Hideyuki Sano
