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Covid-19 global pandemic

Widening gap between value and growth stocks will narrow over time

19 August 2020

Technology euphoria

The numbers 700, 9988, 9618 and 9999 are unlikely to be significant in numerology or some sought-after 4-D numbers, but investors are increasingly able to rattle them off as easily as they can place an order at a fast-food restaurant counter.

For the record, these numbers are the tickers for Tencent, Alibaba, JD.com and NetEase.

Indeed, Asia has caught the technology euphoria, especially North Asian high-growth tech firms enjoying the same rally that has gripped United States markets, led by the technology and biotech sectors.

There is a high concentration of technology stocks among the big-capitalisation firms in North Asia. These have seen spectacular gains this year, propelling some into the rare US$1 trillion (S$1.37 trillion) market cap category that includes Apple, Amazon, Microsoft and Alphabet (Google).

Beneficiaries of the stay-at-home economy

This optimism is largely supported by massive stimulus from central banks and governments aimed at shielding economies from the damage of the pandemic and to ensure a faster recovery.

The pandemic and remote working arrangements of many organisations have benefited tech, software, applications, e-commerce and communications-related companies.

This outperformance of growth versus value stocks can be seen from the 22.8 per cent year-to-date gain for the iShares Russell 1000 Growth Index exchange-traded fund (ETF) versus the 11.5 per cent decline for the iShares Russell 1000 Value ETF.

This trend is also similarly displayed by the MSCI indexes. The broader benchmark MSCI World Index is up only 1.7% for the year, but the MSCI World Growth Index has surged ahead with a 18.1% gain, far outpacing the benchmark index.

In comparison, the MSCI World Value Index is down 13.8% for the year, severely underperforming the benchmark index.

Similarly, large-cap stocks have performed better than small caps. In this health crisis, size – as measured by market cap – does matter, as the MSCI World Large Cap Index is leading with a 2.5% gain so far this year, surpassing the minus 5.8 per cent for the MSCI World Small Cap Index.

More questions than answers

Once again, the clear winners are growth stocks, and the bigger the market cap, the better.

With the stellar gains of growth stocks, valuations have also rocketed, despite weak economic data.

As stocks go higher, more questions will emerge: Is this tech-led rally convincing and how high will it go? Are the winners of today going to be the winners of tomorrow? Is a bitter winter ahead for markets?
Not a broad-based rally

Markets have largely erased most of the losses seen during the onset of the pandemic. Investors and the markets in general are expecting more fiscal stimulus even if a second major wave of infections hits.

While signs are emerging that economic data and corporate earnings are improving, most are still not at pre-pandemic levels. However, based on current prices, markets are pricing in a quick return to normalcy and optimism about a broad-based improvement in global economic outlook.

A cursory glance at key benchmark equity indices gives a one-dimensional view that global equities have surged ahead, with several indices trading at close to historical all-time highs, ignoring weak economic outlooks and mixed corporate earnings outlooks.

However, a deeper dive into what powered the strong rebound in the past two months reveals that gains were largely confined to several growth sectors, including technology and bio-tech companies.

As a result, many value and cyclical stocks have been left largely out of the recent uptrend.

Gap at an all-time high

Considering the S&P 500 Growth Index versus the S&P 500 Value Index, the discrepancy becomes clearer. As growth stocks powered ahead and cleared the previous highs with consecutive new highs since June, value stocks underperformed and are still trading below the previous historical high. The gap between growth and value stocks has also widened sharply to a recent high early this month.

As a comparison, from 2006 to 2017, the gap was an average difference of 106. From 2018 to last year, it widened to 579. At the start of this year, the gap was 866 but in June it widened steeply to an average of 1,049 (from June to this month).

It is becoming increasingly obvious that the bigger, stronger, better-funded and cash-rich growth companies are likely to surpass the rest of the market.

This is due to their strong revenue and earnings momentum, as well as their ability to gain market share and have ready access to funds to finance operations and expansion.

Key sectors that suffered the brunt of the selling pressure at the height of the pandemic are still down for the year. They include airlines, energy, banking, transport, hotels, restaurants, and others such as leisure, retail, consumer services, insurance and real estate.

Value in value

For cyclical sectors, such as financial, real estate, industrial and materials, the dismal share price performance is likely to improve as economies recover. With the current widening gap between growth and value stocks, prudent investors should consider rebalancing their equity portfolios and moving into some value and cyclical stocks.

In addition, persistently low interest rates, which are likely to stretch into 2022, will also favour value stocks with healthy dividends.

Another noteworthy trend is that despite tensions between the US and Beijing, companies with China exposure have outperformed the broader market.

This is largely due to expectations that China will be the first major economy to show signs of recovery from the pandemic. It is also supported by encouraging economic numbers as business picks up.

Optimism about vaccines will also help to spark interest in most sectors that were hard hit by the pandemic, including banks, real estate, and retail-related stocks.

In Singapore, the market has underperformed most regional and global markets, with a year-to-date decline of 19.5 per cent.

We believe that as economies reopen and economic activity picks up, the hunt for value and yields will return.

Our picks in the value and cyclical sectors include:

  1. Ascendas Reit,
  2. CapitaLand Commercial Trust,
  3. CapitaLand,
  4. CapitaLand Mall Trust,
  5. City Developments,
  6. Frasers Logistics and Commercial Trust,
  7. NetLink NBN Trust,
  8. Singtel,
  9. ST Engineering,
  10. Suntec Reit,
  11. United Overseas Bank and
  12. UOL Group.

A version of this article was first featured in The Straits Times (Business Section, Page 12) on 17 August 2020. 

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