Macro
Value Stocks at 0.6 P/E Ratio vs Growth, Cheapest Since 2001
Value stocks' P/E ratio at 0.6 vs. growth's 0.78, presenting rare buying opportunity amid market highs.
Key Takeaway
- Value stocks are trading at a P/E ratio of 0.6 relative to growth stocks, significantly below the median of 0.78 since 2001.
- Improving earnings trends in financials and potential support from commodity prices could boost value stocks' outlook.
- Despite recession risks, deeply-discounted value shares may become more attractive if the tech rally continues and concerns about a bubble grow.
Value Stocks' Valuation Gap
Value stocks have seen their valuations plummet to levels rarely observed in the past two decades, making them increasingly attractive compared to their growth counterparts. The price-to-earnings (P/E) ratio of the S&P Value Index relative to the S&P Growth Index currently stands at approximately 0.6, significantly below its median of 0.78 since 2001, according to Bloomberg data. This stark valuation gap suggests that value stocks may offer a refuge for investors concerned about the broader market's elevated valuations.
When compared to the entire S&P 500, value stocks also appear undervalued. Despite the broader market's rise to record highs, value-stock multiples remain in line with their five-year average. However, this does not guarantee an immediate turnaround for value stocks, as growth stocks have been rewarded for their superior earnings growth. Bloomberg Intelligence data indicates that the profit-growth gap between value and growth stocks is substantial but is expected to narrow later this year.
Improving Earnings Trends
The outlook for value stocks may improve as profit trends shift. Earnings trends for US financials, the largest group in the S&P Value Index, are showing signs of improvement, which could extend their revival this year. Additionally, increasing demand for power and raw materials driven by new technology applications, such as generative AI, is likely to support commodity prices. This, in turn, will benefit major value sectors like energy and utility stocks.
However, both value and growth stocks face risks in a potential recession. Historically, stocks have experienced steep double-digit losses during downturns, with the S&P Value Index underperforming during the bear markets following the pandemic and the global financial crisis. Nevertheless, value shares saw a smaller decline and a quicker recovery from the 2001 downturn, when growth stocks were hit hard by the dot-com bust. This historical parallel may be worth considering, especially as the recent tech rally raises concerns about another potential bubble.
Corporate Bonds' Appeal
High-grade corporate bonds are presenting a compelling alternative to equities, with credit trading at its largest value gap with equities in over 20 years. This trend is reinvigorating the conviction of credit investors, such as Morgan Stanley Wealth Management and Tikehau Capital, who are navigating risk premiums nearing post-crisis lows over sovereigns. "For the first time in years, you are now getting paid to be invested in quality credit," said Raphael Thuin, head of capital market strategies at Tikehau Capital. He added that it is "a true alternative to lower yielding equities, trading at or close to all-time highs."
Morgan Stanley's Chief Investment Officer, Lisa Shalett, noted that the 12-month returns from investment-grade credit could "rival those of equities" on a risk-adjusted basis. Stocks have seen their valuations soar since the S&P 500's near 30% rally in late 2023, while bonds have been constrained by expectations of prolonged high interest rates from the Federal Reserve. The earnings yield on the S&P 500 is now nearly two percentage points below the average bond returns for triple-B rated firms, the weakest segment of the high-grade market.
Street Views
- Simon White, Bloomberg Intelligence (Bullish on value sectors such as energy and utility stocks):
"Increasing power and raw-material demand from new technology applications — like generative AI — is likely to support commodity prices, which will benefit big value sectors such as energy and utility stocks."
