Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 365

Will value stocks benefit from the market's inflection point?

Two dominant investment styles are value versus growth. Value investors look for undervalued stocks while growth investors prefer companies with strong earnings growth potential. While value investing has outperformed over the long term, its underperformance in recent years, particularly in the recent selloff, has caused many to question when the promised value recovery will occur.

To shed some light on this, it is helpful to understand when value has outperformed in the past and the market conditions that led to this.

Where are the value stocks?

Value stocks are typically found in the more cyclical parts of the market such as the Financials, Resources and Consumer Discretionary sectors. These stocks are more sensitive to broader economic conditions, compared to defensive sectors such as Healthcare, Utilities, and Consumer Staples.

Value stocks tend to outperform when economic conditions are improving. In such an environment, the earnings growth outlook from the cyclical parts of the market improves relative to defensive sectors. This drives a rotation out of defensives and into cyclicals, leading to a period of relative outperformance by value.

The second point is that value stocks typically perform better in a rising interest rate environment. This is the result of two factors.

Firstly, rising interest rates usually correspond with improving economic conditions, which as mentioned above, generally favours value.

Secondly, rising interest rates increase the discount rate applied to future earnings and in general, ‘growthier’ stocks are more impacted as a greater proportion of their valuation is based on long-term future earnings. Therefore, a higher discount rate has a bigger impact on the valuation of growth stocks than it does on value stocks, which are more driven by nearer-term earnings and dividends.

In light of this, it’s easy to see why the past few years have been difficult for value investing, as global economic growth has been patchy, and we have been in a lower for longer interest rate environment.

The chart below shows how value stocks do better coming out of recessions, but how much growth has won in recent years.

This environment has been very favourable to stocks offering perceived defensive characteristics, such as infrastructure, or strong organic growth, such as healthcare. Valuations of these types of stocks have pushed up to high levels, both in absolute terms and versus their own historical valuation metrics. At the same time, value stocks have lagged and the valuation gap between cheap and expensive stocks is currently at record levels.

Value fighting back

In the second half of 2019, it appeared there was some light at the end of the tunnel. Global growth was starting to pick up, led by the US, as trade tensions eased and the UK election saw a resolution of the Brexit impasse. Bond yields were starting to tick up and value began logging several months of outperformance.

However, the COVID-19 pandemic put a halt to this, seeing economic growth collapse, interest rates slashed, and investors taking flight to ‘safe haven’ stocks. These factors predictably saw value underperform during the sell-off.

Tellingly, however, since its bottom in late March, the market has rallied sharply, led by cyclicals, and value outperformed strongly in April and May. Over this period, the Perennial Value Australian Shares Trust (PVAST) delivered a return of 19.9% versus the 14.1% return of the benchmark S&P/ASX 300 index. We believe the fund’s ‘true to label’ value approach was an important driver of outperformance during the rally.

The key point is that value tends to outperform not when a crisis is unfolding, but rather, in its aftermath. This is when either the bubbles of euphoria that had been driving the market up may have burst, or the fears that had driven the market down have been realised and dealt with. At this point, investors form the conclusion that the economy will recover, and life will go on. They then seek out solid, reliable, reasonably priced businesses to invest in – in other words, they look to value stocks.

These periods have also shown that style rotation, when it occurs, can happen sharply. When valuation dispersion reaches extreme levels, such as we are seeing today, something usually gives and mean reversion kicks in, resulting in a period of strong outperformance for value investing.

If current trends continue, then the impacts from COVID-19 may be less severe than feared and economies may bounce back. If this is the case, we will have an improving economic outlook, interest rates already at extremely low levels and unlikely to go any lower, and valuation dispersion at record levels. In effect, all the preconditions would be in place for a rotation to value.

Not only does maintaining an exposure to value alongside other styles provide a form of diversification in a portfolio, but after a long period in the wilderness, the tide may be turning in value’s favour.

 

Stephen Bruce is a Director of Perennial Value Management and Portfolio Manager of the Perennial Value Australian Shares Trust. This article is general information and does not consider the circumstances of any investor.

 

  •   8 July 2020
  • 1
  •      
  •   

RELATED ARTICLES

Inflation: friend or foe of Value stocks in 2022?

Will the drought break for value stocks continue?

After 30 years of investing, I prefer to skip this party

banner

Most viewed in recent weeks

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

The investing rule that explains the next market crash

What if investment success depends less on picking the right assets and more on understanding the decisions of other investors? A principle borrowed from game theory offers a different perspective on markets.

Latest Updates

Fixed interest

Higher yields are creating opportunities in global bonds

Bond markets are adjusting to a new reality, but not in the ways investors expect. With markets repricing and capital competing for attention, investors may need to rethink where resilience and opportunity lie. 

Economy

Are we in a recession?

What if the warning signs are already everywhere? From supermarket aisles to company failures, investors are being bombarded with recession signals. But most face a different risk that can be just as dangerous for portfolios. 

SMSF strategies

Meg on SMSFs - Division 296 actuarial certificates

The tax bill might be yours, but the event that caused it may not be. A key Division 296 calculation can sometimes attribute earnings in ways that many SMSF trustees won't instinctively expect or fully appreciate.

Property

The first impact of negative gearing reform is not the tax bill

Negative gearing changes formally begin in 2027, but the first consequences may already be here. A subtle shift is quietly influencing who can borrow, how much they can access and which property strategies still stack up.

Economy

The oil market is running out of easy answers

The biggest threat to markets may not be what investors are watching. The numbers have stopped adding up and supply is harder to measure, with forecasts becoming simple guesses. A more fragile reality is being masked.

Investment strategies

The state of investor knowledge in Australia

Australians are investing more than ever, yet a surprising divide is emerging between those building wealth effectively and those making costly mistakes. Surprisingly, the gap has little to do with income, age or starting capital.

Taxation

Complexity and capital gains

A case study shows that the ‘30% minimum CGT’ is a poorly conceived tax that adds significant complexity to an already over-complex system. A less complicated model would create a much fairer progressive tax scale.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.