Vaccines Likely Can’t Vanquish Value’s Headwinds

March is just two days old, and already it has brought a flurry of COVID vaccine-related news—refueling hopes for an economic boom as society gains immunity to the virus and the world can finally reopen. Across most think tanks and official forecasters, expectations for fast growth abound—not just for 2021, but for 2022 and beyond. Conventional wisdom holds that this will benefit all the traditional value industries, including Industrials and Energy. Not coincidentally, value stocks have popped again lately. We have written before why we expect growth stocks to keep leading overall as this bull market rolls on, notwithstanding some sentiment-driven wiggles along the way—and we won’t rehash that full argument here. But we do think it is worth noting that value enthusiasm seemingly ignores a lot of fundamental headwinds plaguing value-heavy sectors and industries. Considering stock categories generally do best when worried investors underrate opportunity, the current scenario doesn’t seem to augur well for value.

To see this in action, consider air travel—widely believed to be on the cusp of a post-COVID boom as people worldwide unleash their pent-up wanderlust. At a consumer level, this is possibly true, to a degree. Many folks are sick of confinement and, with savings rates remaining sky-high, many probably have the spare cash to fund a jaunt to their favorite tropical beach, theme park, international metropolis or mountain adventure. But when an event pulls consumption forward or pushes it back, like Japanese sales taxes in recent years have two times, the burst doesn’t usually prove lasting. In this case, we are a little skeptical a potential reopening resurgence in consumer travel demand would amount to a new, higher, lasting trend. Markets are quite well aware of this theory too, suggesting these expectations are reflected in stock prices now—and likely to a great extent.

Regardless, though, business travel doesn’t seem to have as much immediate mojo. A recent study, highlighted in Bloomberg Tuesday, showed total global spending on business travel dropped from $1.43 trillion in 2019 to just $694 billion last year, and it projects a rather ho-hum recovery.^[i] The projected 21% growth for 2021 would leave it -42% below 2019’s peak.^[ii] The researchers don’t anticipate business travel regaining its pre-pandemic peak until 2025. Turns out meetings that used to require jet setting can accomplish as much over video conference, helping businesses free up cash for other endeavors.

This isn’t great news for airlines. According to an industry trade group, business travelers represent 30% of US airlines’ total trips—but about half of their revenues, thanks to those comfy-looking and mega-expensive business class seats we always pass on our way down to coach.^[iii] Without business travelers paying mountains of money to fly while lying down after binging on free champagne, airlines will have a harder time breaking even (never mind profiting) without cutting flights or filling every last coach seat with vacationers—which will be obviously hard to do if some still practice social distancing by keeping middle seats empty or if they jack up prices to offset the hit from absent business travelers.

In short, without a fast return to breakeven in business travel, it is difficult to envision airlines doing as well as people seem to expect later this year and next. That has knock-on effects for their Industrials sector peers in the aerospace industry as well as hotel and restaurant chains—all big value plays. But it also suggests oil demand will have a hard time meeting expectations, as lower business travel means less demand for jet fuel. As that reality—along with the reality of recovering oil production—dawns on today’s enthusiastic investors, it wouldn’t surprise us to see oil prices even out a bit. Energy companies’ earnings are sensitive to oil prices, so even modest weakness relative to expectations on that front could prove a disappointment to the high expectations seemingly baked into this year’s early Energy stock rally.

The classic recipe for bull markets is a bullish cocktail of low expectations and underappreciated strength. That sets up the proverbial wall of worry that stocks love to climb. Many value-heavy industries today face the opposite: high expectations alongside pockets of fundamental weakness that people are all too eager to overlook or explain away. That doesn’t necessarily mean value stocks will fall, as a rising tide tends to lift all boats. But until investors capitulate and throw in the towel on these industries, sending expectations back down, value seems unlikely to enjoy lasting, cumulative leadership. In our view, that seems more likely to follow an eventual, traditional bear market than come in the immediate future.