Where has the value rally been strongest?

Regions that struggled to produce big tech winners over the past decade are now enjoying the value rally.

This year has been the year of value’s comeback. After around a decade of underperformance, shares deemed to be “cheap” have provided investors with the best returns.

Driving the performance of value has been the so-called reflation or recovery trade. Since the announcement of several successful vaccines in November 2020, expectations for global economic growth have gradually picked up. Successful vaccine roll-outs have seen investors increasingly confident that economies will be able to emerge from lockdowns this year.

On top of this, the victory of Joe Biden and the Democratic Party in US elections has seen the US embark on a big fiscal spending spree, which is also reviving growth expectations, both in the US and globally. So far, these bullish expectations have shown up in the economic data, with all sorts of figures demonstrating that economies around the world are staging strong recoveries.

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While all this has translated into strong performance for value and cyclical stocks, it has also meant relative poor performance for growth stocks. Such companies tend to perform better when broader economic growth is scarce, as it was for much of the 2010s. In a low-growth economy, so the theory goes, investors are prepared to pay a premium for stocks showing growth. Added to that, brisk economic growth has raised the risk for some that inflation and interest rates will increase. Rising inflation and rates are seen as bad for growth stocks.

All  this has meant that regions with more value and cyclical-heavy market indices have performed better. For example, the cyclical and value-heavy MSCI Europe Index has been one of the better performing indices this year. Notably, it has outperformed the MSCI USA Index so far this year, bucking the trend of the past decade. 

However, where has the outperformance of value compared to other stocks been most pronounced? According to data from FE Analytics to 16 June, the MSCI Europe Value Index has been among one of the best performing value-screened indices, with a return of 12.9% year to date, in sterling terms.

However, as noted, the broader European index is heavily value and cyclical-focused. As a result, the value-screened European index has only outperformed the broader European index by around 0.5%.

In contrast, the MSCI USA Value index has performed almost as well as the MSCI Europe Value index, with the former returning 12.7%. That is far above the performance of the broad MSCI USA index, which has returned 8.9% since the start of the year. This larger differential is due to the prominence of tech and growth-style stocks in the US index.

Tech and growth stocks were among the best performers of the past decade, including companies such as Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT). As a result, they came to dominate the US index. When outperformance shifted to value stocks, this created a drag on the performance of the US market.

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A large difference in performance between value and the broad index can also be seen in emerging markets. The MSCI Emerging Markets Index has returned 3.6% year to date. In contrast, the MSCI Emerging Markets Value index has returned almost 7%.

Much like in the US, the emerging market index became increasingly dominated by tech and growth stocks over the past decade. Chiefly, this was down to the huge growth of several Chinese companies such as Tencent (SEHK:700), Alibaba (NYSE:BABA), JD.com (NASDAQ:JD) and Meituan (SEHK:390). A decade ago, when the emerging market index was dominated by traditional value stocks, we might expect the performance differential between the value-screened index and the broad index to be much smaller.

However, it is important to note that while the European index has enjoyed gains recently due to the dominance of value and cyclical stocks, it does suggest a weakness in Europe’s economy. While the 2010s saw large tech and digital companies rise to prominence in the US and Asia, Europe failed to create companies of equal significance, for the most part.

This potentially points to a deeper weakness in terms of innovation and company formation in Europe. Indeed, 20 years ago Europe was home to 40 of the 100 most valuable companies in the world based on market capitalisation. That has since fallen to just 15. While the lack of large-cap tech and growth stocks has allowed Europe to pull ahead in the recent value rally, it raises concerns about Europe as a place for investors over the longer term.