While global equity markets experienced a historic negative start to the new year, the pullback may set the stage for increased opportunities for value investors.
In today’s environment, I believe value investing is an area that has the potential to outperform. The transition would be sharp from 2015, when growth stocks outperformed value by a considerable amount. Interestingly, we saw similar outperformance of growth over value when stock prices rose in 2000. When the bubble burst, it was followed by a multi-year period of outperformance by value.
Volatility dominates early 2016
In early 2016, the United States and many international equity markets have experienced the worst start to a year in history. Investor sentiment has been negative, volatility doubled, and markets were down 10% — entering correction territory in just 12 days of trading.
China slowdown, oil’s plunge rattle global markets
China’s economic slowdown, the continued plunge of oil prices, and strengthening dollar all have played a role in the downturn. Fears of a continued slowdown in China’s economy and its implications on global demand have intensified. Oil prices plunged to unthinkable levels below $30 per barrel, which markets view as a harbinger of a dramatic slowing economic activity in developed nations and lower revenues for emerging markets. The U.S. dollar strength is resulting in a slowdown in growth of U.S. earnings and wreaking havoc in emerging markets by making dollar-denominated debt more expensive to service.
In my view, China is not experiencing a hard landing, but a deliberate, albeit painful, transition to a consumption-driven economy. China always bears watching, but many fears today are exaggerated. China has enough policy ammunition to protect its currency and stimulate its economy.
Less-accommodative Fed raises worries
Investors’ negative sentiment is also the result of the Federal Reserve’s less accommodative stance, having introduced the first rate hike in nearly a decade in December. Markets believe there is a higher probability of a U.S. recession. There are more negative economic data points, but I don’t think it is a sign of a recession. We’ve seen similar pullbacks in the markets that have not been a harbinger of a recession. Regarding oil, now that markets have seen prices fall below $30 a barrel, you can expect to see a supply response with meaningful cuts in production as many oil companies cannot generate profits at these levels. We are also seeing a continued strengthening of demand.
Opportunity for value investors
Beneath the market headlines, we are also seeing value assert itself in sector after sector, as a market that had previously priced stocks with a great deal of parity is now seeing a significant dispersion. We view these conditions as an opportunity that can reward value investing, active investing, and patient investing.