February 2017

Exploring value opportunities

The current market dynamics appear supportive for companies tilted towards the value factor. As reflation takes hold, areas of the market that are geared towards a pickup in global growth may perform well. Beyond the value factor, we find potential opportunities in the Eurozone, Japan and in the financial sector.

The “value” factor is one that tries to capture undervalued companies based on fundamental measures. Historical data show the long-term outperformance potential of value-tilted strategies. In the current reflationary environment, we believe value stocks are well positioned to outperform peers given our expectation of a continued economic recovery and steeper yield curves. For those investors able to invest more tactically, our analysis suggests there are pockets of value to be found in specific regions and sectors, particularly outside the U.S., which may offer additional short-term opportunities to potentially generate returns in a reflationary environment.

Figure 1: Value equities vs the broad market 2012–2017

Figure 1: Value equities vs the broad market

Source: BlackRock, Thomson Reuters, March 1, 2017
Notes: Equity series are based on the MSCI World Value Index vs. the MSCI World Index, rebased to 100 on 2/29/2012.


The value factor

Historically, value tends to outperform in reflationary environments, arguably akin to the current one. As the reflation trend spreads beyond the U.S. to the rest of the world, we believe a pickup in global growth and steepening yield curves favors value equities. Recent strong performance has done very little to reverse years of value underperforming amid sluggish global growth (figure 1). Therefore, we see more room for the value trade to run. In addition to the potential opportunity in the current environment, an allocation to the value factor could have a strategic role to play in a portfolio in order to seek the long-term risk premium of the factor.

Japan

Japanese equities are trading at an 11% discount to the developed market counterparts on a 12-month forward P/E basis.1 At the same time, impressive earnings beta to global growth has fostered in 4Q16 one of the best earnings season in Japan in nearly a decade (12% year-on year EPS growth). Continued yield curve management from the central bank, positive global growth expectations and better corporate governance should be positive for Japanese equities. That said, sustained yen strength or rising protectionism could be a concern and the limits of monetary policy mean Japan could have fewer too.

Eurozone

Eurozone equities may offer attractive relative value opportunities, trading at a 10% discount to developed markets on a 12-month forward P/E basis.1 Recent inflows have paled so far in comparison to the $34bn that flowed out of European equity ETPs globally in 2016.2 An uptick in earnings estimates coupled with light investor positioning mean that Eurozone stocks may be offering attractive opportunities. We remain, however, cognizant of significant political risk in a busy election year and a potential for a slowdown in global reflation sentiment. Nonetheless, we expect the region to fare well in a better global growth environment and current valuations may be an attractive entry point.

Financials

Despite recent performance, global financials are still trading at a 54% discount to developed equities on a 12- month forward P/B basis. While it is important to note that the post-crisis regulatory regime and business mix mean that some of the re-rating is structural (earnings potential has changed), we think current economic conditions could help lift the sector’s profitability. Steepening yield curves may help provide relief to bank net interest margins while the prospect for less regulatory pressure in the U.S. is helping investor sentiment which could be a material driver of upward earnings revisions. Additionally, we find the sector has a strong beta to global growth, partly given the pro-cyclical nature of the demand for financial services. Investors should keep in mind potential headwinds which include: policy undershooting expectations in the U.S., and structural challenges such as balance sheet health in the euro zone periphery.


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Authors
Investment Strategist for ETF Investment Strategy
Analyst for ETF Investment Strategy