Back in January we published a note, Value is Back and This Time it Could be Here to Stay, arguing that the strong relative performance of the value factor in December 2021 would likely persist in 2022. Since the beginning of this year, all three regional SPDR® MSCI Value ETFs have outperformed their respective market benchmarks.1
We highlighted this opportunity on the basis that the primary driver for markets would likely be the normalisation of interest rate policy. The US Federal Reserve (“Fed”) and other central banks have been forced to wind down quantitative easing bond purchasing programs and raise the short-term target rates in order to fight back against the high level of price inflation in the economy.
Interest rates are often used as the discount rate of future earnings in equity price valuations. In the past decade, modern monetary theory (“MMT”) has led central banks to keep interest rates artificially low. This led to an asset price rally fuelled by the expansion of earnings multiples. As Figure 1 demonstrates, in European equities, this phenomenon disproportionally benefitted the valuation of growth stocks.
Figure 1: Relative Price to FWD Earnings Ratio (Last 10 Years)
As the European Central Bank has indicated a willingness to follow the Fed on its path away from MMT and toward a more normal interest rate environment, we have seen this growth valuation premium level off. Meanwhile, the relative valuation premium remains elevated above +1 standard deviation of the long-run median average. This would indicate that there is more valuation compression to come in growth stocks and value may continue to present an interesting opportunity.
Figure 2 shows how the distribution of excess performance has been balanced across sectors this year. The SPDR® MSCI Europe Value UCITS ETF tracks the MSCI Europe Value Exposure Select Index, which is sector-neutral at rebalance. This means that the majority of relative performance is attributable to stock selection, not merely sector allocation disparities. This in an important component to this trade. Investors can focus on the factor specifically without making an overall sector bet.
Figure 2: Fed Funds Rate and Index Returns (Trailing 6-Month Returns)
We believe the outperformance of value year to date could be just the beginning, especially in European equities, based on the fundamental change in central bank policy expected in 2022. We would caution investors that this trade is unlikely to occur without volatility and thus would suggest investors use a selective approach to targeting strong value factor exposure, for example by using the SPDR® MSCI Europe Value UCITS ETF.
Investors using value strategies to take advantage of cheap stocks need to protect their portfolios against stocks that are cheap for a reason. Value Exposure Select strategies, such as the SPDR® MSCI Europe Value UCITS ETF, allow investors to access strong value factor exposure while seeking to avoid value traps by using a light quality touch. To learn more about this ETF, and to view its full performance history, please visit the fund page.
SPDR® ETFs offer a suite of Value Exposure Select strategies in World, USA and European exposures, which track the MSCI Value Exposure Select family of indices.
1 Source: Morningstar, as of 31 May 2022.
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