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October 9, 2024
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Why Value? How History Informs the Current Market

Cory Martin, CEO of Barrow Hanley, believes the current economic climate is perfect for undervalued stocks.

Cory Martin, CEO of Barrow Hanley, believes the current economic climate is perfect for undervalued stocks.

Cory Martin, CEO of Barrow Hanley, believes the current economic climate is perfect for undervalued stocks. In a recent webinar Cory highlights the risks of today’s tech-driven market and predicts a shift back to value investing. With tech stocks showing unsustainable valuations, Martin sees a correction coming, creating opportunities for undervalued companies to thrive. Discover why now might be the ideal time to embrace value investing.

Years of abnormal fiscal and monetary policies, along with geopolitical fragmentation, have prompted some asset owners to scrutinize the principles of value investing. But there is a sound basis for why the current economic backdrop is poised to favor undervalued stocks — and it could catapult profitable opportunities on the horizon.

But only if investors give the market time.

In value investing, patience is a virtue. That was the underlying message Cory Martin, Barrow Hanley CEO and Executive Director, Equity Portfolio Manager, shared with advisors and investors in a recent webinar. While unpacking the trends impacting value performance, Martin said it is critical to evaluate the investment strategy through a historical lens.

“If you have been in the business less than 15 years, you are probably asking yourself why value? because it has been such a prolonged period of excess return for growth,” explained Martin, who joined Barrow Hanley 25 years ago. “Obviously, you want to have growth and value. But historically, value has been the dominant way to make money, and it will work again.”

It is possible that history is repeating itself, he added. Martin pointed to striking similarities between the excessive speculation of the Dot Com era of the late ’90s, and today’s market dominance of hyper-growth tech stocks. Fueled by the explosive popularity of the internet, the tech boom led to bullish stock valuations and unchecked growth. When expected earnings failed to materialize, the bubble burst in fantastic fashion.

Today, memories of the fallout have made investors wary of the frenzy surrounding the Generative AI industry. While it remains to be seen whether Generative AI will live up to the hype, Martin said businesses were being similarly valued based on their future potential, rather than on their actual value, which could spell trouble down the road.

Martin believes investors’ worries about the tech sector are causing a shift away from momentum trading and could invite a reversion to the mean.

Earlier this year, numbers revealed that the “Magnificent 7” (Mag 7) drove 75% of returns and they remain an expensively valued area of the market. Presently, the trailing price-to-earnings multiple for the Mag 7 stands at 35.1x. In fact, when viewing the Mag 7 as its own “sector,” it is the largest sector in the benchmark (roughly 29%) — yet the group’s earnings contribution is just 21%.

Lofty valuations in such a narrow market are an unprecedented phenomenon, Martin said.

“It’s the most concentrated market we’ve ever seen,” he added. “It is not sustainable. The only way that it is sustainable is if each and every company in the Mag 7 meets or exceeds forward earnings expectations. One miss and the stocks could get severely punished.”

Major companies such as Tesla experienced sharp stock declines when they failed to meet expected delivery targets in Q1 2024, for example. Back in the 90s, tech companies affected by the bubble burst either faded or folded completely.

“We know how this story ends,” Martin said.

Which could be why value investing is bracing for a comeback. While Martin does not expect companies like NVIDIA or Microsoft to collapse, he believes a renewed focus on earnings means a correction is imminent, carving out new lanes of opportunity for undervalued companies to thrive.

The relative valuation of value stocks when compared to growth stocks is near all-time lows. The largest constituents in value, such as Energy, Financials, Utilities, Consumer Discretionary, Communication Services, and Consumer Staples, tend to generate more reasonable valuation levels on a price-to-sales basis.

“This is not a rational situation, and it will change over time,” said Martin, adding that looking at periods on a rolling basis proves this out.

Since 1932, periods of growth outperformance are typically followed by sustained periods of value outperformance. Nearly every 10-year period, outside of the tech bubble and the abnormal fiscal and monetary environment experienced today, shows value outperforming growth. In the U.S., these periods generate average excess value returns of 118% and on average last about seven years.

Today, reasonable economic and earnings growth, positive real interest rates, and opportunities arising in markets like China, are turning the cycle to favor value stocks. This environment favors Barrow Hanley’s value discipline of owning undervalued, strong companies with asymmetric return opportunities.

“We think we’re in one of these prolonged cycles that got temporarily sidetracked,” Martin said. “Whenever you can marry low-leverage rates with above-average quality, you’re going to win, and that’s going to be alpha.”

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All opinions expressed in video and thought leadership content constitute Barrow Hanley’s opinion at the time of issuance. The information provided is for informational purposes only and is not intended to be an offer, solicitation, or recommendation with respect to the purchase or sale of any security, nor a recommendation of services supplied by any money management organization. Past performance is not indicative of future results.

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