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A Redefinition of Value Investing

14 September 2020Equities

US stocks fell in the week ending 11 September, with the tech-heavy Nasdaq Composite retreating 4.06%. Citi analysts note that most of the selloff has been narrowly concentrated in COVID-19 defensive segments (such as technology), thus pointing to rotation trades rather than a pure risk-off scenario. Risks of a liquidity squeeze also appear manageable given a dovish US Federal Reserve.

Recent economic data (e.g. US ISM readings, nonfarm payrolls, China and Taiwan trade data) also underscored a continued recovery, supporting Citi analysts’ view of a cyclical catch up. Diversification into cyclical markets like Europe, EM Asia and Latin America, particularly value stocks with still subdued valuations, remains preferred.

What is value investing?

Until recent years, value investing, or investing in stocks with a low market price relative to accounting book value, had a nearly 85 year history of outperformance. However, given the realities of today’s economic environment, Citi analysts believe there may be new factors that can identify where "value" is for certain companies and consider four strategies:

  • Dividend growth companies – ability to pay and grow dividends.
  • Growth at a reasonable price ("GARP") – identifying likely earnings growth though margin expansion, and not overpaying for it.
  • Companies less sensitive to rising interest rates – these tend to be less sensitive to interest rate shocks given higher near-term earnings and cash flow yields.
  • Economically sensitive sectors and regions that are cheap relative to COVID-19 winners – Europe and parts of EM are historically cheap relative to US and may also benefit from a weakening USD.

A Redefinition of Value Investing
Past performance is no guarantee of future results. Real results may vary.

Identifying the new value

Looking beyond COVID-19, Citi analysts also see potential from certain sectors and regions that have underperformed so far this year. As US companies consider diversifying supply chains out of China amid continued tensions between the world’s two largest economies, countries in southeast Asia and Latin America could see a boost in foreign investment.

Reshoring back to the US and government-driven infrastructure spending may benefit certain small-and mid-sized manufacturing companies in the US. Banks may be able to reduce the level of loan loss provisions sooner-than-expected and if governments remain supportive through 2020, banks may be well-positioned to move on from this crisis much stronger than following the Great Financial Crisis.

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Assessing the Pullback in the Technology Sector

The technology sector is seeing some pressure after a rally that has surpassed expectations. COVID-19 cyclicals were more resilient, consistent with Citi analysts’ preference of rotating from growth to value stocks amid a cyclical recovery. Looking ahead, Citi analysts believe this is more likely a correction rather than the start of a broader downturn, as the cyclical recovery remains intact. Nevertheless, further volatility is expected due to the upcoming US Presidential election and ongoing pandemic. With US equity valuations at a historic high relative to others, investors could also look to diversify into non-US markets.

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Going Cyclical in Asia

Investors in Asia have flocked to COVID-19 defensive or growth sectors like technology this year, while COVID-19 cyclical or value sectors have lagged significantly. Citi analysts expect this relative performance to reverse, at least partially, as re-opening takes place.

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EquitiesAsia PacEmerging Markets

Position for Growth, Rate Risks and Weaker USD

Two major risks for markets going forward are likely to be sustaining the growth that is underway, and sensitivity to rising interest rates. On the other hand, Citi analysts believe the broad US dollar basket may have peaked in early 2017 and expect the USD to depreciate over the next 5-10 years. Thus, there are likely to be diversification benefits from owning non-US assets.

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