So far this year US value stocks have outperformed their growth counterparts by a whopping 21% (as at 24 May). But what’s behind the rotation?
It can partly be explained by the huge spike in bond yields, which has seen the 10-year US Treasury yield rise from 1.51% at the start of the year to 2.85% at the end of May. Growth stocks derated as a result, because their distant cash flows are very sensitive to changes in discount rates.
However, a less-appreciated reason is that traditional value indices are currently concentrated in more defensive industries, which tend to benefit in stagflation environments.
So, contrary to popular belief, the value style of investing does not simply mean buying companies in cyclical sectors such as financials and energy. In fact, these sectors only account for 24% of the MSCI USA Value Index’s market cap.
The reality is that neither value nor growth indices hold a constant set of companies’ shares over time. As growth companies mature, their valuations can suffer at which point they may exit the growth universe.
Similarly, when cheaper companies begin attracting investors, value stocks may see their valuations rise and exit the value universe.
Betting on value today is a defensive trade
In general, defensive stocks tend to have a market beta of less than 1, meaning they will outperform the broader market when the index falls.
In contrast, cyclical stocks tend to have a market beta of more than 1, meaning they will underperform when the index falls.
Although value investing is often associated with cyclical companies, most “bargain stocks” in the US equity market are actually defensively tilted rather than cyclical.
For example, 75% of the market cap in the MSCI USA Value Index has a stock-level market beta less than 0.9 (i.e. low beta), compared to only 15% for the MSCI USA Growth Index.
This was not always the case. In the past, value’s defensive exposure was much lower and its cyclical exposure was much higher.
In 2009, around 41% of value’s market cap had a beta less than 0.9, while 44% had a beta greater than 1.1.
In other words, investors should not assume anything permanent about value’s cyclicality and the prevailing market environment illustrates this point very clearly.
Looking ahead, any bet on future performance should factor in this economic tilt.
FAQs
Although value investing is often associated with cyclical companies, most “bargain stocks” in the US equity market are actually defensively tilted rather than cyclical.
Is the stock defensive or cyclical? ›
A defensive stock is one that provides a consistent dividend and stable earnings regardless of the state of the overall stock market or economy. Cyclical risk is the risk of business cycles or other economic cycles adversely affecting an investment, asset class or individual company's profits.
Is value a defensive factor? ›
Betting on value today is a defensive trade
In general, defensive stocks tend to have a market beta of less than 1, meaning they will outperform the broader market when the index falls. In contrast, cyclical stocks tend to have a market beta of more than 1, meaning they will underperform when the index falls.
Are value and defensive stocks the same? ›
A defensive investment strategy is a conservative method of portfolio allocation that emphasizes capital preservation. A value stock is a stock that tends to trade at a lower price relative to its fundamentals, making it appealing to value investors.
What are considered defensive stocks? ›
Defensive stocks are those that tend to provide stable earnings and consistent returns, even during an economic downturn. Shares of well-established companies in the consumer staples, utilities, and healthcare sectors are common examples of defensive stocks.
Which stocks are considered cyclical? ›
Cyclical stocks represent companies that make or sell discretionary items and services that are in demand when the economy is doing well. They include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers.
Are defensive stocks non cyclical? ›
Defensive stocks are also sometimes referred to as non-cyclical stocks because they don't follow the cycles of the economy. In fact, they typically underperform when the market is up. Cyclical stocks, on the other hand, are stocks that tend to do well when the economy is doing well.
Is Tesla cyclical or defensive? ›
Tesla (TSLA)
Tesla is an automaker, which puts it in a decidedly cyclical industry.
What is an example of a defensive industry? ›
The defensive sector includes companies that tend to be stable regardless of market performance. Stocks in the defensive sector include companies in household products, food producers, pharmaceuticals, and utilities. Examples of companies in this sector include Walmart (WMT), Tyson Foods (TSN), and FedEx (FDX).
What is a value stock? ›
A value stock is trading at levels that are perceived to be below its fundamentals. Common characteristics of value stocks include high dividend yield, low P/B ratio, and a low P/E ratio. A value stock typically has a bargain-price as investors see the company as unfavorable in the marketplace.
Consumer defensive companies are engaged in the manufacturing of food, beverages, household/personal products, packaging, or tobacco. Procter & Gamble PG, PepsiCo PEP, and Costco Wholesale COST are among the largest companies in the consumer defensive index.
What are the best defensive stocks to buy? ›
Top defense stocks to buy in 2023
| Company | Defense Focus |
|---|
| Lockheed Martin (NYSE:LMT) | Aviation, space, and missiles |
| Boeing (NYSE:BA) | Aircraft, space, and helicopters |
| Northrop Grumman (NYSE:NOC) | Nuclear efforts, bombers, space |
| General Dynamics (NYSE:GD) | Shipbuilding, defense IT, tanks |
2 more rowsApr 17, 2023
Value stocks have conservative debt loads. Growth stocks often take a more aggressive stance, using debt to expand quickly.
Are real estate stocks defensive? ›
The business cycle refers to the alternating phases of economic growth and decline. read more Examples of Defensive sector stocks include utilities, consumer durables, pharmaceuticals, and real estate.
Are cyclicals growth or value? ›
Cyclical businesses perform well during economic expansions but typically experience significantly declining sales and profits during recessions and other challenging economic times. Cyclical stocks tend to move up and down in value alongside the market.
Is Tesla a cyclical stock? ›
Tesla Is Behaving As A Deep Cyclical Business. Recent developments and massive price cuts in order to move inventory show signs that Tesla is prepared to overproduce in order take and retain market share.
What is considered value stocks? ›
What Is a Value Stock? A value stock refers to shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales, making it appealing to value investors. A value stock can generally be contrasted with a growth stock.
What is the difference between value and growth cycle? ›
The main difference between growth and value stocks is that value stocks are companies investors think are undervalued by the market, and growth stocks are companies that investors think will deliver better-than-average returns.
Are growth stocks cyclical or non cyclical? ›
History shows that the performance of growth stocks and value stocks has been cyclical.
Is Apple cyclical or non cyclical? ›
Examples of cyclical stocks include Starbucks, Delta Air Lines, Disney, and Apple. Non-cyclical stocks are the opposite: They're also called defensive stocks because consumers continue to spend on these categories even during economic downturns.
A rating of 49 puts General Motors Company (GM) near the top of the Consumer Cyclical sector according to InvestorsObserver.
Is Amazon considered a cyclical stock? ›
Mentioned in this article
Amazon.com, Inc. (AMZN) is around the top of the Consumer Cyclical sector according to InvestorsObserver. AMZN received an overall rating of 66, which means that it scores higher than 66% of stocks.
What are 3 examples of value stocks? ›
Bank of America's Best Value Stocks Of 2023
- Ameriprise Financial, Inc. (AMP) Price/Earnings Ratio. ...
- CF Industries Holdings, Inc. (CF) Price/Earnings Ratio. ...
- Exelon Corp. (EXC) ...
- Nucor Corporation (NUE) Price/Earnings Ratio. ...
- NVR, Inc. (NVR) ...
- Principal Financial Group Inc. (PFG) ...
- T-Mobile US, Inc. (TMUS) ...
- United Rentals, Inc. (URI)
Buffett follows the Benjamin Graham school of value investing. Value investors look for securities with prices that are unjustifiably low based on their intrinsic worth. There isn't a universally accepted way to determine intrinsic worth, but it's most often estimated by analyzing a company's fundamentals.
What are the best deep value stocks? ›
Deep value stocks include Citigroup, General Motors, T. Rowe Price Group, Medical Properties Trust, and Celanese.
