About That Vaccine-Driven Value Rally…

Editors’ Note: MarketMinder does not make individual security recommendations. The below merely represent a broader theme we wish to highlight.

One year ago Tuesday, Pfizer and BioNTech announced that their COVID vaccine candidate had shown promising results in phase 3 trials, and value bulls got a shot in the arm. Value stocks normally lead early in a bull market, but growth had led since stocks bottomed late the prior March. The vaccine announcement led value bulls to argue they weren’t wrong, just early—value had lagged because lingering lockdowns were crimping demand, they claimed, and vaccinations would get the party started for real. A year later, that hasn’t exactly worked out as they anticipated.

True, value has led cumulatively since Pfizer’s momentous press release. But as Exhibit 1 shows, the margin is small. Moreover, value’s leadership occurred in two short bursts: one last November, and one this January and February. Since value’s returns relative to growth peaked on May 13, growth is up 20.1%.^[i] Value? Just 5.0%.^[ii] Moreover, since the bull market began on March 23, 2020, growth is beating value by a whopping 31 percentage points—121.4% to 90.4%.^[iii]

Exhibit 1: So Much for the Hot Vax Value Boom

Source: FactSet, as of 11/9/2021. MSCI World Growth and Value Index returns with net dividends, 3/23/2020 – 11/9/2021. Indexed to 1 at 3/23/2020.

In our view, value’s twin runs were sentiment-fueled—enthusiasm first over the vaccines’ existence, then their rollout. Stocks priced those events very quickly and then moved on, as is typical of very widely discussed developments. Markets move most on surprises, and the prospect of vaccines enabling broader reopening was baked in lightning-fast, leaving a dearth of fundamental support for value leadership.

That remains the case today, in our view. Value stocks generally have lower gross profit margins and rely on cost-cutting and catch-up growth in an economic recovery to boost earnings. The US’s economic recovery from lockdowns is complete (it is now in expansion, having surpassed the pre-downturn GDP peak), and there are already signs growth is returning to its pre-pandemic slow trend. That works against value stocks. They also tend to rely on bank lending or bond issuance to fund growth, making it hard to finance expansion when the yield curve is flatter, as it is now.

Growth stocks are much better positioned in this environment. As our recent commentary showed, they tend to have much fatter gross margins, giving them much more cash flow to plow back into the core business. They also have a big cushion to weather rising cost pressures and strong pricing power, thanks to their strong brand names, globally dominant business lines and ties to long-term technological trends. That puts them in the catbird seat relative to value in this time of rising shipping, labor and input costs.

Growth’s leadership probably also means we are later in this market cycle than most analysts presume, as growth normally leads in a bull market’s later stages. That doesn’t mean the end is anywhere close to imminent, as there are plenty of bricks left in the wall of worry. But it does suggest value’s real time to shine probably won’t arrive until after the next bear market. In the meantime, because value stocks are so economically sensitive, we suspect maintaining a big overweight to value probably isn’t the most beneficial approach.