The value versus growth equity story has been one of two halves in the past two decades. This has been the case not only in developed markets – which tend to command the most attention from investors and researchers alike – but also in emerging ones. Emerging markets value stocks performed strongly between 2000 and 2010 before succumbing to the resurgence in growth stocks from 2011 onwards.
During the first wave of Covid-19, global economic growth collapsed while long-term interest rates dropped to extremely low levels. The 10-year US Treasury yields nosedived to an historic low of 0.5% in early August 2020. At that stage, corporate earnings growth had become extremely scarce, and investors flocked to any stock showing minimal signs of growth.
Sectors with a growth angle substantially outperformed the broader market, and in particular more cyclical ones. In emerging markets, Chinese internet stocks were perhaps the most telling example of such an extreme performance gap. Even as global equities markets collapsed, in March 2020, these stocks emerged from the turmoil virtually unscathed, rallying strongly in the recovery that followed.
The progress made on vaccines to fight the pandemic proved to be a turning point for style performance. With the promising results of several vaccine-candidates released in the last quarter of 2020, global economic growth prospects improved, and long-term interest rates rose steeply from depressed levels. For instance, 10-year US Treasury yields rose from 0.5% to 1.7% in the space of just eight months.
At the same time, energy prices and commodity prices generally started to rally as well. As a result, the earnings outlook for companies in the Energy and Materials sectors, as well as in the Financial sector, improved significantly. Corporate earnings growth became less scarce across the board and growth stocks started to underperform their value counterparts.
Many investors interpret this simplistically as a rotation from growth to value. But there’s more to it than that, as value comes in different shades. We have witnessed the initial rotation phase from growth into value. This was a classic start to the reflation trade, with investors buying into cheap laggards, resulting in deep value stocks initially outperforming the broader market.
We believe that further outperformance lies ahead for value, as long as the economic outlook continues to improveWe believe that further outperformance lies ahead for value, as long as the economic outlook continues to improve. However, we expect investors to become increasingly selective in their choice of value stocks. Investors will start to look for stocks that deliver on their perceived value, showing better earnings potential in a normalization of the macroeconomic backdrop.
Therefore, after the first wave of value investing has boosted all cheap stocks, we expect the second wave to focus on what we call ‘value with a future’; in other words, companies with inexpensive valuations that do not discount their sustained earnings growth ahead. Given the polarization we have seen in emerging markets over the course of 2020, there still are attractively valued opportunities to choose from.
With the gradual comeback of value stocks, we only made minor adjustments to our positions in emerging markets. We modestly increased our exposure to deeper value by taking profits in selective growth names in China, but also in some IT hardware stocks in Taiwan and South Korea, all of which outperformed strongly in 2020.
With the proceeds, we increased our positions in Financials and Materials, where we believe some attractive value opportunities are to be found. For example, we participated in the IPO of a Brazilian company that has a large market share in iron ore exports to steel-hungry China. After an initial share price return of 22%, the company is still trading at a very low price-to-earnings ratio of six times.
We also increased our positions in the Financials sector in India and Greece, and initiated positions in a South Korean manufacturer of construction equipment. We think this company, which is trading at an attractive valuation, will benefit from the global increase in infrastructure investments over the next couple of years.