It's been a hard year for the value stocks that our dividend strategy typically invests in. Growth stocks have outperformed them this year (as they did in 2019), such that the valuation gap between the two has hit a historical high - growth stocks had become 230% more expensive than value firms by the end of September based on a composite of four valuation measures - P/E, P/CF, P/B and dividend yield.
We've long been arguing that this extreme valuation gap is unwarranted and unsustainable, and that investors have just been waiting for a catalyst to rotate, or rebalance, back into value.
And now it seems that an initial catalyst may have arrived.
The end of the pandemic in sight?
On Monday 9 November, drugs giant Pfizer and its partner BioNTech announced that initial tests of their vaccine against coronavirus suggested that it was 90% effective in protecting against the disease - a much better result than had been expected. This announcement triggered the sharpest rise in value stocks on record as many investors bought the companies that had lagged the most since the start of the lockdowns. Conversely, momentum suffered its worst-ever fall.
We think this move was a clear indication that the market is looking for reasons to rotate into value.
Even though the vaccine isn't ready to be distributed, the Pfizer news removed a significant amount of the uncertainty that investors hate so much. With the end of the pandemic now in sight, the market now sees light at the end of the tunnel, especially with more vaccines still to come.
That said, it's not going to be a steady rise for value from here as there are still further uncertainties to overcome. In particular, the US elections didn't provide the clear outcome that investors were hoping for, with President Trump yet to concede and two Senate run-offs still to come in January. The political situation in the US has implications for trade wars, the US's relationship with China, and whether there will be more fiscal stimulus. Once this uncertainty fades away, we believe value stocks could continue to outperform.
The end of the party for big tech?