The tide continues to turn for value-growth dynamic

Reece Birtles

Martin Currie

The value investment style has faced material performance headwinds for a prolonged period, as evidenced in the long run of relative underperformance of Value-style market indices, both domestically in Australia and globally.

These headwinds had been driven by a combination of factors including benign global inflation rates, sub-trend economic growth, and historically low monetary policy settings. This has supported increasingly high valuations across certain segments of the market, particularly in technology and other growth-style sectors.

We have been talking about the inevitable rebound in value performance for more than 12 months as economies recover from the COVID-19 downturn, and why investors should be positioned in quality Australian value stocks.

As the economic reopening gathers momentum, as predicted, the tide has continued to turn in favour of value performance, and over recent months, growth stocks have seen a severe price reversion. 

In the following wire, we discuss:

  • the backdrop to the recent performance upswing for value
  • the drivers that support a continuation of the performance reversion
  • why Australia, in particular, represents a meaningful opportunity to take advantage of this theme
  • why now, more than ever, is the time to invest in value

Value's relative underperformance has bottomed

Since Q3 2021, we have seen a meaningful reversal of the relative performance between Value and Growth. While it is naturally extremely challenging to accurately call the bottom of a cycle, it appears that the performance tide has now turned, both locally and globally.  

Relative performance of MSCI Style indices

Past performance is not a guide to future returns. Source: Martin Currie Australia, Bloomberg, MSCI. As of 31 March 2022.

The shift in relative performance has correlated closely with strengthening momentum behind the reopening of global economies, as COVID-19 restrictions have been progressively eased and borders have begun to reopen. This has been associated with an acceleration of key inflation measures, as well as expectations for the normalisation of extremely loose monetary policy settings.

Growth P/E ratios are not supported by results

It is interesting to note that the rate of EPS growth for value and growth style stocks had been relatively consistent over time. This highlights that the most recent divergence in performance for the two investment styles has been primarily driven by inflated prices being paid for growth stock exposures in recent years, rather than fund flows supporting more profitable companies. This has resulted in the significant expansion of P/E multiples for growth stocks.

Notably, we have seen another instance of this trend occur in the late 1990s with the dot-com bubble, which was associated with a rapid rise in technology stock valuations fuelled by widespread investment in internet-based companies. 

This led to a significant stretching of growth stock P/E multiples, which sharply de-rated when the bubble burst in the early 2000s, helping to spark a strong reversion in relative value performance.

Technology stocks are once again at the forefront of the current growth stock multiple expansion. While the sample set of these occurrences is obviously small, this does highlight the potential danger of investing in such a high-risk momentum play, as well as the upside for value should a normalisation subsequently occur. 

P/E ratios of MSCI Australia style indices (NTM)

Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet; as of 31 March 2022.

Value rewarded in February reporting season

During the recent February 2022 domestic reporting season, we saw quite meaningful broker EPS revisions across stocks trading on high valuation multiples – i.e., the typical growth-style exposures. 

The notable P/E expansions had increased the level of ‘risk’ baked into these growth names and these revisions resulted in quite significant de-rates for growth stocks. This has exacerbated the severity of the performance unwind that we have seen playing out throughout 2022.

Conversely, stocks trading on lower multiples, typically value-style exposures such as commodities, energy, and financials stocks, saw more upward EPS revisions, and thus a more promising price reaction through reporting season. 

EPS revision (median change)

Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet; as of 28 February 2022. Data for the S&P/ASX 200 Index. Calculated using the weighted average of broker consensus forecasts of each holding –because of this, the returns quoted are estimated figures and are therefore not guaranteed. 

Value spreads remain attractive despite uptick

Even accounting for the recent uptick in value performance, we see ongoing material upside for the value style. Our proprietary methodology shows that the fair value gap between the most attractive value-style stocks and the broader market, or what we call the ‘value spread’, remains at a notably stretched level versus history.

Despite the sharp reversion of relative performance, the spread remains the widest it has been since early 2012, highlighting that as the spread narrows, the return opportunity that our model estimates are still very significant. This further shows the extent to which P/E expansion across growth-style stocks has to unwind and highlights the magnitude of the upside scenario that we see for value stocks looking forward.

MCA Value spread

Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet; as of 31 March 2022. Data calculated for the representative Martin Currie Australia Value Equity account relative to the S&P/ASX 200.

Inflationary forces provide value tailwind

Following a prolonged period of challenging growth and exacerbated by strict COVID-19 restrictions, global economies have now begun to reopen in earnest. This has been associated with a material inflationary spike with CPI prints across major economies pushing to the strongest levels seen since the recovery from the GFC.

While the inflationary spike itself has been significant, importantly beneath the headline strength we are also now seeing a reconfiguration of the underlying drivers of inflation. A clear dynamic over the past decade has been that non-tradeable (services) inflation has been stronger than tradeable (goods) inflation.

This strong demand for services had meant that many growth-style companies were able to maintain quite healthy earnings while their input costs fell, supporting the outperformance over the typical value-style companies.

The recent inflationary spike that we have seen has reflected a swing back to tradeables inflation, with increasing goods and commodities prices helping to generate momentum behind the move. Increasing goods costs with relatively static input costs will help to create a beneficial environment for Value stocks such as resources companies and other goods producers, strengthening the tailwind for Value’s relative outperformance going forward. 

Australian inflation: tradable vs non-tradable

Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet; as of 31 March 2022.

Economic factors create solid value backdrop

Value stocks have historically shown a strong performance correlation with strengthening economic growth and movements in bond yields. These factors have clearly provided a headwind for value in recent years, with pandemic-induced lockdowns driving a global economic slowdown and inciting an extreme monetary policy response from central banks.

As restrictions continue to be eased, measures of global growth, such as the world Purchasing Managers Index (PMI), are reflecting a rapid economic recovery, driving a material spike in inflation and raising expectations of monetary policy tightening through 2022. 

We believe that these conditions will provide a supportive backdrop for the continued outperformance of value stocks going forward.

The sharpness of the recovery from COVID-19 lockdowns around the globe has seen a significant spike in the world PMI, without an equivalent narrowing of value spreads. This enduring gap further highlights the significant opportunity that value exposures represent as the global economy continues to reopen. Value style stocks remain cheap relative to the broader market despite the period of outperformance through the year-to-date.

World PMI and the MCA Value Spread (inverted)

Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet; as of 31 March 2022. Value Spread calculated for the representative Martin Currie Australia Value Equity account relative to the S&P/ASX 200. 

Rising yields have historically shown a strong correlation with positive Value style returns and a narrowing of the Value spread. Yields had been trending lower since the GFC as monetary policy settings were progressively loosened in an effort to spark growth. 

While central banks are naturally being quite cautious, monetary policy settings are beginning to normalise around the globe, and forecasts for major economies suggest that rates will continue to rise, which will push bond yields higher and should therefore provide a tailwind for relative value performance.

Relative performance of MSCI style indices and US bonds

Past performance is not guide to future returns. The investment vehicles shown may have different risk profiles and a direct comparison may not be appropriate. Source: Martin Currie Australia, FactSet; as of 31 March 2022.

Australia represents a compelling value opportunity 

Within this improving thematic for value, we believe that the Australian market is particularly well-placed to outperform in an improving economic environment, relative to the US or other global market equivalents.

The Australian equity market is notably value-tilted, with a large weighting to very high-quality financials, which will benefit from rising interest rates, and materials/resources, which will benefit from supply chain limitations/disruptions and growing momentum behind the global push toward net-zero.

Conversely, the US market is more leveraged to the tech-led growth thematic, with major technology stocks such as Apple and Amazon making up more than a quarter of the total market capitalisation of the S&P500 index and representing 8 of its top 10 constituents by weight.

Australian vs US sector weights

Past performance is not a guide to future returns. Source: Martin Currie Australia, Bloomberg; as of 31 March 2022. 

While there are of course value stock opportunities within the US market, the large concentration in growth-style names trading on significant multiples highlights the better positioning of the Australian market as an opportunity to capitalise on the rotation to Value.

We would note that thematic influences associated with these differences have already driven a clear performance dispersion between the two markets over the year to date, with Australia’s greater value-orientation supporting outperformance relative to the US and other global markets. With growing momentum behind the rotation back to value, we see a meaningful opportunity for this relative outperformance to continue. 

Index cumulative returns this year

Past performance is not a guide to future returns. Source: Martin Currie Australia, Bloomberg; as of 21 April 2022.

The time for value is now

The economic tide is turning, and Australia presents a particularly compelling opportunity to capitalise on this trend given the market’s strong value orientation. Extremely high valuations across growth stocks have highlighted the degree of downside risk associated with these exposures, and while the performance reversion has already been sharp, there is notable scope for this to persist. 

Examples of our Select 'Value' Opportunities

Our stock selection, driven by our proprietary fundamental analysis process, is positioned to benefit from a continuation of the rotation to Value. Our Australian focus provides the opportunity to benefit from the geographic advantage within this thematic environment. 

Woodside Petroleum

Our overweight position in oil and gas producer Woodside Petroleum (WPL) was initiated in 2017 in response to oil prices trading below our view of long-term normal, which was not reflected in the market’s thinking. We have subsequently increased our overweight positioning reflecting the company’s exposure to the energy transition, expanding project pipeline, and upside associated with the merger with BHP's oil and gas business.

South32

We maintain a high conviction overweight allocation to South32 (S32), a diversified metals and mining company. The company offers attractive and well-diversified exposure to commodities such as aluminium, which we see as key for the energy transition push. We consider S32’s asset base to have high cash generation capacity which provides a material return opportunity for shareholders. The stock has been very strong in recent months, supported by broad commodity price strength, but on balance of the remaining opportunities we still see further upside for S32 going forward.

Worley

We have been expanding our overweight allocation to global engineering, advisory and project management services company Worley (WOR) since late 2020, given the company’s beneficial exposure to the capex required to achieve the energy transition to Net Zero emissions by 2050, as well as increasing capex in its traditional businesses of oil and gas, chemicals and resources.

Nine Entertainment

Although television networks have seen a significant decline in audience and advertising dollars, growth in new Broadcaster video on demand (BVOD) platforms has reversed audience and revenue declines. Nine Entertainment (NEC) are continuing to pivot their business in a way that will help the structural declines in the publishing business along with creating growth in digital subscriptions and advertising. We believe that the market is yet to fully value the shift from "old media" to growth business and the stabilisation of the more structurally challenged parts of the business.

ANZ

Australia and New Zealand Banking Group (ANZ) remains the best valued Australian bank with a solid cost-out story to evolve, and a favourable business banking skew. A mix of initial reinvestment and Board focus should ultimately see this management team deliver the cost savings needed to improve earnings. The business banking skew should see growth return in 2022 whilst bad and doubtful debts remain subdued. This is partly built into valuations, but we expect to see further upside for ANZ versus peers.

Medibank Private

We believe that the quality and earnings stability of Medibank Private (MPL), Australia’s largest health provider, together with growth opportunities from diversification and consolidation, are being undervalued. We expect MPL to outperform private health insurance industry peers due to its superior ability to manage costs and innovate, whilst finding new sources of growth as the company pursues a broader role in healthcare.

Vicinity Centres

Retail REITs were significantly sold down during the height of COVID-19 social restrictions; however, the retail sector has been bouncing back with tenant demand for leasing improving. Whilst Vicinity Centres (VCX) share price has started to recover, it is still trading well below pre-COVID levels and at a very large discount to Net Asset Value. As retail sales and foot traffic further recovers, we expect the discount to reduce over time. Recent asset transactions in the retail property sector further point to the valuation upside for VCX.

QBE

We initiated an overweight allocation to diversified global insurer QBE Insurance Group (QBE) in December 2021 reflecting a strong Valuation signal on the stock, which had notably underperformed global peers despite solid underwriting discipline and reserving practices. Recent company results have highlighted that the business recovery is well underway, which we believe will be supportive of expanding margins, driving upgrades to consensus and providing share price support.

Insignia 

Insignia (IFL) is a focused player in the financial intermediary space that operates a low-cost carrier model. IFL remains a turnaround story and doubled down on the synergy extraction via the MLC deal. Delivering on these cost savings is the key to the value opportunity, as this should more than offset core platform business decline from margin contraction and set the group up for the future of advice delivery. This creates greater execution risk, but also a larger prize and better industry structure that we believe is being under-estimated by the market.

Alumina

Alumina (AWC) is a leading Australian resource company and one of the world's largest, lowest cost alumina (the feedstock for aluminium smelting) producers through its joint venture with Alcoa. We see it as a high-quality company, with valuation support, and increasing margins as demand for Aluminium, and therefore Alumina, increases with global decarbonisation. The high alumina price currently reflects supply disruption from the Russia/Ukraine conflict, further enhancing AWC's near term earnings

The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable

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The Martin Currie Select Opportunities Fund provides investors with a diversified exposure to our highest conviction stock ideas with Valuation potential, while balancing risks through our focus on Quality and Direction. Find out more by visiting our website


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(1) Past performance is not a guide to future returns. The investment vehicles shown may have different risk profiles and a direct comparison may not be appropriate. (2) The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable. Important information This publication is issued for information purposes only and does not constitute investment or financial product advice. It expresses no views as to the suitability of the services or other matters described in this document as to the individual circumstances, objectives, financial situation, or needs of any recipient. You should assess whether the information is appropriate for you and consider obtaining independent taxation, legal, financial or other professional advice before making an investment decision. Please read the relevant Product Disclosure Statements (PDSs) and any associated reference documents before making an investment decision. In accordance with the Design and Distribution Obligations and Product Interventions Powers requirements, we maintain Target Market Determinations (TMD) for each of our Funds. All documents can be found via (VIEW LINK) or by calling 1800 673 776. Issued by Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827). Franklin Templeton Australia Limited as Responsible Entity has appointed Martin Currie Australia as the fund manager of the Martin Currie Equity Income Fund (ARSN 150 751 821). 3.8 k

Reece Birtles
Chief Investment Officer
Martin Currie

Reece is a Non-Executive Director of Martin Currie Investment Management Limited (MCIM). He is also a member of Martin Currie’s Executive Committee and Investment Executive Committee. Reece has held the role of Chief Investment Officer (CIO) of...

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