Nov 23, 2021
Portfolio Manager Alessandro Dicorrado explains why super-cheap valuations suggest a cheerful outlook for value investors.
Value equities remain extraordinarily cheap, both historically and relative to other parts of the stock market – even after the value rally in Q4 2020 and at the start of 2021. And we think there are potential catalysts for value from here, including rising bond yields and inflation.
We don’t expect runaway price rises, but in 2022 there is clearly a possibility that inflation and bond yields will move higher. Even small moves could be very impactful on a market that has come to rely on extremely low interest rates and inflation. That said, we do not believe we require inflation for our value-focused portfolio to prosper. But we think it could be an additional tailwind.
Inflation will lead to higher discount rates, which lowers the normalised valuations of businesses. That is likely to particularly weigh on some of the more expensive companies in the stock market. There are under-priced companies in a variety of industries, and I think the market will come to realise that it is better in this environment to pay 10x earnings to own such stocks, rather than 35x earnings for some other companies.
At the same time, while some sectors will be hampered by rising costs, parts of the value universe will likely benefit from inflation – such as certain resources businesses, which will be boosted by higher commodity prices, and banks, which become more profitable as interest rates rise.
About half of the portfolio is allocated to cyclical or recovery-related themes, with the rest invested in idiosyncratic, less correlated, single-stock stories. The themes include travel-related companies, in expectation of a COVID recovery in travel; the auto supply chain, where we think prices have been extraordinarily cheap; and energy, where we see some interesting value opportunities in oil & gas for long-term investors.
Given where the market is, investors clearly have to be mindful of a potential sell-off. How a value portfolio will fare depends on what drives it, and we may outperform or underperform in the short term. But if the sell-off is driven by investors becoming concerned about valuations, then we would expect to do better than the market, and value would be a relatively defensive allocation in that context. Clearly, a stock-market decline would also present opportunities to pick up some good businesses at appealing valuations.
Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company.
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests.
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With Western central-bank policy normalising, economic growth rates diverging and global trade still readjusting to life after lockdown, investors have a complex environment to navigate in 2022.
Ninety One’s portfolio managers assess the outlook across their asset classes and regions.
Our team also takes a deep dive into the outlook for emerging markets, as well as into how sustainability will drive investment outcomes next year and beyond.