by Chris Marx, AllianceBernstein
Global equities are notching new highs, valuations are elevated and talk of market bubbles is increasingly common. Yet, by our measure, the potential for outperformance in value stocks has rarely been better. How can that be?
We’d chalk it up to the market’s residual crisis reflexes. Investors no longer fear systemic disaster, but they remain guarded about the future amid shifting rich-world monetary policies and a wobbly global economic recovery. So, though valuations climbed across the board last year, most of the action went to already popular, richly valued stocks (typically companies offering the fastest or the most reliable, immediate profit growth), while low-multiple, controversial stocks were left standing by the side of the dance floor.
In the aftermath of last year’s market party, the most expensive quintile of global stocks now trades at 8.1 times book value, or almost four times higher than the global stock market as a whole—the second-highest premium since 1971 (Display 1). Earnings multiples are similarly hefty. Meanwhile, the cheapest quintile sells at 0.9 times book value, a 57% discount to the market and around its historical average in both absolute and relative terms.
In the past, differences of this magnitude between the valuations of cheap and expensive stocks have heralded outsized value outperformance. Eventually, either the controversies that caused the disparity resolved themselves or cheap stocks simply became too enticing to resist.
The last time value stocks lagged expensive ones by this much in a bull market was during the late 1990s, when red-hot technology and telecom stocks left almost everything else in the dust. After that bubble popped, value stocks reclaimed the lead, scoring hefty relative gains that more than made up for previous underperformance. Since spreads are so wide today, we see large payoff potential over time for strategies that concentrate on inexpensive stocks and avoid expensive ones.
Substantial portions of the consumer-cyclicals, consumer-staples, medical and technology sectors rank among the priciest of global equities (Display 2). While many of these stocks owe their premiums to their well-deserved reputations as safe havens, this expensive group also includes a number of massively large-cap, high-growth Internet stocks, notably Amazon, Facebook and Netflix. Cheap stocks are dominated by financials and other interest-rate-sensitive sectors, namely housing-related and utilities stocks, which each lagged the market by about 20% in 2013.
The average market capitalization of the priciest quintile is $17.5 billion, nearly twice the size of the cheapest quintile. Half of the global market’s capitalization is now in the two most expensive quintiles.
These trends have stark implications for passive cap-weighted-index tracking strategies, which by their nature will be blindly tethered to these risky concentrations. In contrast, environments like today’s are ready-made for stock pickers. Indeed, our research is uncovering widespread value opportunities, with lingering anxieties pushing cheap stocks to some of their deepest discounts versus pricey stocks in more than 40 years—across all sectors of the market. Though it may take time for others to come around, we think the potential in wallflower value stocks today makes it well worth taking the chance to ask them for a dance.
Chris Marx is a Senior Portfolio Manager on AllianceBernstein’s (NYSE:AB) Global Value Equities team.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
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