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Dividend Update: All set for a style reversal?

24 November 2020

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.

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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?
But the gap between value and growth isn’t just about how cheap value stocks have become. It’s also in part due to the extreme valuations of many growth stocks.

We believe that tech stocks’ stellar rise may be approaching an end, as there are a number of clouds on the horizon.

Governments around the world have become concerned about the growing influence of major tech firms. The Chinese government recently pulled the IPO of Ant, China’s biggest financial technology group (and Alibaba’s payment arm), seemingly due to concerns about Alibaba becoming too powerful. European governments have announced an investigation into the misuse of data by Amazon, while in the US Google is set to face an antitrust lawsuit, accused of unfair practices to extend its monopoly position.

So the big tech companies are faced with a general perception that they have become too powerful and that they can’t be allowed to continue to grow forever. Some politicians even want to break them up, although we believe this is unlikely for now. But investors need to be aware that governments might make things more difficult for the big tech firms from here.

Another consideration is that these firms have become so big they’re now treading on each other’s toes. For example, Apple is taking steps to develop its own search engine, while Microsoft’s cloud business is competing with that of Amazon. That’s another sign that they can’t go on expanding indefinitely, and that their current share prices are probably pricing in too much growth.

We don’t think it’s too late to join the ride
What should investors make of all this? The valuation gap between value and growth stocks has come in from 230% to roughly 200%, so have they missed the opportunity to capitalise on the mispricing? We think not – as we’ve said before, we believe a fair premium for growth stocks relative to value is around 80% given their greater growth potential, but they’re still way above that level. In short, we believe the rotation from growth into value still has a long way to run if economic and political uncertainty continues to dissipate.  

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