Value stocks have rebounded recently, driven by hopes that an exit from the pandemic will buoy the global economy. The gap between value and growth was especially pronounced in US markets. Sectors such as financials and energy, which are more cyclically sensitive, tend to do well in economic recoveries and are more heavily represented in value benchmarks. Growth stocks, meanwhile, may face pressure from rising interest rates, which tend to affect their multiples more than those of their value peers.
The growth-value debate will rage on. But we think there’s a more important question that transcends traditional style definitions, considering how different post-COVID-19 normalization may look from past recoveries. In fact, we believe investors should widen the lens beyond a growth-versus-value assessment to determine a company’s true potential.
Three Signs of Strong Recovery Potential
In our view, the key question is whether the quality a company offers comes at a reasonable cost. And in the aftermath of an unprecedented economic crisis, determining quality will now come down to how fast a company can recover its earnings as conditions improve. To identify such companies, we believe investors should look for three key growth drivers that are very specific to today’s conditions:
1. The reopening trade: Companies that are most likely to benefit from economies opening back up will be the most obvious growth driver in 2021. But the recovery path won’t be the usual slog. Strong pent-up business and consumer demand for goods will accelerate the turnaround once lockdowns are fully removed, which will play out in the markets rather swiftly. On one hand, many companies will find it easy to post strong earnings growth against last year’s depressed levels, especially in retail and travel, which suffered the most in 2020. On the other hand, it will be easy to identify companies that are struggling to keep up the growth momentum they may have inherited from the pandemic’s demand spike for certain services.
2. Changed behaviors: Consumers do a lot of things differently than they did 12 months ago—more online shopping, use of credit and debit cards over cash, and how they watch their favorite movies and TV shows. Many of these changes will persist. The UK, for instance, recently more than doubled the contactless credit card payment limit to GBP100 (Display left). For businesses, working from home and less employee travel has reduced expenses and helped push up margins. Business equipment rentals, which usually take a hit in recessions, held steady through the pandemic (Display right). All told, this could mean 2020 winners will keep winning, while some companies that are expecting a “return to normal” may never realize it.
3. Margin expansion: Profitability growth will be critical now, especially when so many companies were forgiven for margin compression in 2020. If moderate inflation returns, as expected, the test will be even harder in 2021 compared to pre-crisis expectations. Companies may grow; but if their margins still shrink, the market will penalize them. Pricing power will be ever more essential, so companies with differentiated or highly desirable products and services that are in short supply should do well.
With the global economy on the mend, investors will continue to reassess the relative advantages of value and growth stocks alike. But their assessments are happening amid high price/earnings multiples not seen since the late 1990s, which is raising the market’s overall risk profile. That’s why high-quality companies with reasonable price/earnings and transparent earnings streams should have the advantage. Simplistically focusing on either value or growth likely misses the bigger picture: companies with resilient business models amid changing market and macroeconomic conditions should be able to deliver solid returns in a post-pandemic world, no matter what style benchmark their stock belongs to.
- James T. Tierney, Jr.
- Chief Investment Officer—Concentrated US Growth
- Dev Chakrabarti
- SVP/Co-CIO, Concentrated Equities - Global—Concentrated Equities-Global-ABL
- Mark Phelps
- Chief Investment Officer—Concentrated Global Growth at AllianceBernstein