Could It Be Value Stocks’ Time to Shine?

The stock market’s rapid and violent selloff in February and March has a long-time value skeptic making a big call on the beaten-up style of investing. Wells Fargo’s head of equity strategy, Christopher Harvey, has advocated in favor of momentum and growth stocks in recent years—but now he sees conditions ripe for a value rally.

Growth stocks are most simply defined as those companies that are expected to increase their earnings or revenues at a faster rate than the rest of the market. Value stocks, meanwhile, are those that trade at a discount to the market on various fundamental measures. The logic goes that those stocks will eventually trade like the rest of the market, and their valuation multiples will rise.

But value stocks can also be cheap for a reason. Buying high price-to-earnings-multiple growth stocks over the past decade has been a winning strategy. The technology-heavy group’s consistent business growth during the longest economic expansion in U.S. history allowed the denominator to keep up with the soaring numerator. 

The Russell 1000 Growth index has more than doubled the Russell 1000 Value index’s return over the past decade: Growth stocks have returned 254%, including dividends, since April 14, 2010, while their value peers have managed a 119% return.

The growth and value indexes are off 8.5% and 21.3%, respectively, since the start of this year. Coming at the end of a decade of growth outperformance, that has pushed value’s relative discount to near-record levels. Since 1995, the valuation difference between the top quintile of the market and the bottom has been wider only once, in late 2008 and early 2009—the depths of the global financial crisis.

“Currently, the median stock in [the bottom] quintile trades below liquidation (book) value,” Harvey wrote. “In our experience when stocks trade below liquidation value and cannot get access to capital they become ‘going concerns.’ Conversely, when stocks are trading below liquidation value but can access capital they become great value opportunities.”

Harvey notes that credit spreads have tightened significantly since last month, making it cheaper and easier for companies to secure credit. Combined with the discount to growth, Harvey sees value’s turn to shine.

“By our analysis, March’s epic stock selloff provided the necessary valuation dislocation required to incentivize the marginal investor to take on the high risk, poor sentiment, and negative momentum associated with the reversion-to-the-mean strategy (i.e., Value),” Harvey wrote on Monday.

He acknowledges that it is a contrarian view. With a recession looming, the kinds of companies that can keep growing regardless of the backdrop tend to outperform, while those that have other issues or depend on economic factors they can’t control tend to stay depressed.

But Harvey maintains that conditions are trending in the right direction for value stocks, which could leave them with greater tailwinds than the reigning growth shares.