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.

 

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

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Latest Updates

Economy

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Investing

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Property

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Shares

ASX reporting season: Room for optimism

Despite mixed ASX results, the market has shown surprising resilience. With rate cuts ahead and economic conditions improving, investors should look beyond short-term noise and position for a potential cyclical upswing.

Property

A Bunnings play without the hefty price tag

BWT Trust has moved to bring management in house. Meanwhile, many of the properties it leases to Bunnings have been repriced to materially higher rents. This has removed two of the key 'snags' holding back the stock.

Investment strategies

Replacing bank hybrids with something similar

With APRA phasing out bank hybrids from 2027, investors must reassess these complex instruments. A synthetic hybrid strategy may offer similar returns but with greater control and clearer understanding of risks.

Shares

Nvidia's CEO is selling. Here's why Aussie investors should care

The magnitude of founder Jensen Huang’s selldown may seem small, but the signal is hard to ignore. When the person with the clearest insight into the company’s future starts cashing out, it’s worth asking why.

Sponsors

Alliances

© 2025 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.