‘Conditions perfect for value stocks to deliver robust returns’ after passing ten key tests, says River and Mercantile’s Sergeant

Now is the best time for many years to invest in value stocks, with conditions currently perfect for the revival of these out-of-favour investments, according to Hugh Sergeant of River and Mercantile.

Both growth and quality stocks have performed strongly throughout the Covid-19 pandemic, supported by record-low interest rates and relatively strong corporate fundamentals.

But value stocks, on the other hand, remain unloved by investors and have therefore performed less impressively throughout the current crisis. 

However, Sergeant, manager of the UK and Global Recovery funds at River and Mercantile, believes value stocks could surge once the economic storm brought on by Covid-19 passes.

He says: “Value will be back. Value nearly always does well in an economic recovery period, especially if that recovery happens at a time when value is relatively attractively priced, which it most definitely is today.

“Indeed if you were a person from Mars, and all you had was a deep set of data on factor returns and economic and profit cycles over the last 100 years since proper equity markets began, then if you set yourself 10 key tests on whether now was the time to invest in value, recovery and multi-cap stocks then the answer to all those key tests would be very supportive.

“I believe that now is, at least according to the data, the best time to invest in value, recovery and multi-cap that I have seen in my career.”

Sergeant says he has 10 key tests to gauge the right time to invest in value stocks, all of which have now been passed, meaning conditions are perfect for these investments to deliver robust returns.

1. Are we at the cyclical low point for the relative value of value stocks? YES
2. Are we at the cyclical low point for the relative value of recovery stocks? YES
3. Have smaller companies underperformed and are lowly valued? YES
4. Are absolute valuations for value stocks compelling? YES
5. Is the global economy cyclically depressed? YES
6. Are corporate profits depressed? YES
7. Is global economic policy stimulative? YES
8. Are value stocks unloved? YES
9. Are value practitioners withdrawing their investments? YES
10. Is there a catalyst – possible change of economic narrative (reflation)? YES

Sergeant adds: “No one really believes in the recovery yet thanks to huge fears of the second wave. Monetary policy has, in the short term, boosted what has already worked. The short-term fundamentals of the winners of the last ten years have looked much better than those of the laggards.

“Passive and ETF money is also facing in one direction because many value players have been forced out. Everyone is giving up on value and the marginal player has remained a seller.

“But at some time, the elastic band does become too stretched and the fundamentals of value stocks starts to beat very depressed expectations.”

Sergeant says over the next few quarters global economies will continue to recover and the massive monetary and fiscal stimulus will continue to positively impact. Deflation will turn to reflation and bond yields will bottom-out.

“Growth and quality stocks’ relative fundamentals will peak as more cyclical value stocks start to see profits recover. Brought-forward digital spending will struggle to preserve the momentum embedded in many growth and quality stock share prices. And finally, liquidity and passive investing may change direction as momentum shifts from deflation to reflation beneficiaries,” he says.

“Meanwhile asset pricing, such as negative bond yields, has deeply embedded deflation expectations, at a time when economies are recovering, and record levels of monetary and fiscal stimulus have been committed by central banks and governments.

“The post coronavirus crisis period of austerity has been replaced by a far more reflationary mix of policies – surely it is therefore a possibility that the narrative changes direction, from deflation to reflation.”