In my last post, I described how clients worldwide are paying close attention to the macro picture. Here we’ll take a look at another topic that was prominent during my year-end conversations: What could 2019 bring for value stocks? Against the backdrop of the longest bull market in history, value stocks have underperformed for an unusually extended period. Looking ahead, we believe markets should be close to an inflection point.

Value stocks outperform over the long term

To start, it’s important to remind ourselves of the “base case” for investing in value stocks: They have historically outperformed over the long term, as shown below.

Value underperformance unusually long-lived

But is it not uncommon that value investing goes through periods of underperformance relative to the broader market. What has been uncommon has been the length of time low value stocks have underperformed other equities.

The last ten years have been a difficult time for value investors with a marked period of underperformance—in fact, an unusually extended period, as shown below. This can be due to a number of reasons, but key among them has been the unusual level of monetary accommodation provided by low rates and quantitative easing (QE). This has driven risk seeking behavior by investors at the cost of fundamentals that normally provide a catalyst for value stocks. As central banks start to move from easing to tightening, we should be close to an inflection point. Given that the greatest upside happens shortly after an inflection point, investors shouldn’t give up on value now.

Investment implications: Positioning for an inflection point

For investors who want to position themselves to capture the potential upside after an inflection point in the cycle, we believe three sectors could be attractive targets: Financials, Resources and Industrials. The chart below illustrates why these segments are currently undervalued and identifies potential catalysts for realizing value.

These sectors are among those that have struggled more recently relative to the broader market. And this is typical for value stocks, with the key being the catalysts necessary for that value to be realized. As noted in the table above, resolution of trade war rhetoric could be a key to Resources and Industrials seeing a period of outperformance. As expectations for increases in short rates wane, pressure on financials should also ease. A steeper yield curve would be even more of a benefit to help drive earnings for those companies as well.

Value investing is never an easy ride, but that is how investors earn the risk premia they are paid over the long term. This style requires patience and a long-term perspective. While that has been a challenge over the past several years, I believe that it ultimately is a fundamental approach that will benefit investors. And the environment for that to be realized may be upon us.

Stay tuned to SPDR® Blog for updates as the year develops.

Definitions

Book-to-Market Ratio
The book-to-market ratio is used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost, or accounting value. Market value is determined in the stock market through its market capitalization.

Price-to-Book Value Ratio
A valuation metric that compares a stock’s price to the company’s book value, which is calculated by its total assets minus intangible assets and liabilities.