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Are value stocks cyclical or defensive?

05 July 2022 Schroders

 

 
 
 

Are value stocks cyclical or defensive?

Investors may need to rethink their preconceptions about value investing.

So far this year US value stocks have outperformed their growth counterparts by a whopping 21% (as at 24 May). But what’s behind the rotation?

It can partly be explained by the huge spike in bond yields, which has seen the 10-year US Treasury yield rise from 1.51% at the start of the year to 2.85% at the end of May.

Growth stocks derated as a result, because their distant cash flows are very sensitive to changes in discount rates. 

However, a less-appreciated reason is that traditional value indices are currently concentrated in more defensive industries, which tend to benefit in stagflation environments.

So, contrary to popular belief, the value style of investing does not simply mean buying companies in cyclical sectors such as financials and energy. In fact, these sectors only account for 24% of the MSCI USA Value Index’s market cap.

The reality is that neither value nor growth indices hold a constant set of companies’ shares over time. As growth companies mature, their valuations can suffer at which point they may exit the growth universe.

Similarly, when cheaper companies begin attracting investors, value stocks may see their valuations rise and exit the value universe.

Betting on value today is a defensive trade
In general, defensive stocks tend to have a market beta of less than 1, meaning they will outperform the broader market when the index falls.

In contrast, cyclical stocks tend to have a market beta of more than 1, meaning they will underperform when the index falls.

Although value investing is often associated with cyclical companies, most “bargain stocks” in the US equity market are actually defensively tilted rather than cyclical. For example, 75% of the market cap in the MSCI USA Value Index has a stock-level market beta less than 0.9 (i.e. low beta), compared to only 15% for the MSCI USA Growth Index.



This was not always the case. In the past, value’s defensive exposure was much lower and its cyclical exposure was much higher.

In 2009, around 41% of value’s market cap had a beta less than 0.9, while 44% had a beta greater than 1.1.



In other words, investors should not assume anything permanent about value’s cyclicality and the prevailing market environment illustrates this point very clearly.

Looking ahead, any bet on future performance should factor in this economic tilt.

For further information on this topic, and other points of discussion, please visit our insights page.

 

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. The views and opinions contained herein are those of the authors, or the individual to whom they are attributed, and may not necessarily represent views expressed or reflected in other communications, strategies or funds. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. Issued by Schroders Investment Management Ltd registration number: 01893220 (Incorporated in England and Wales) which is authorised and regulated in the UK by the Financial Conduct Authority and an authorised financial services provider in South Africa FSP No: 48998.


 

 

 
 
 
 
 
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