Value rally appears to be durable


Q2 2021 Putnam Large Cap Value Fund Q&A

  • Value stocks continued their strong run throughout the first half of 2021.
  • The quick recovery trade — which favored almost any stock that was cheap — seems to have played out.
  • We are focused on businesses that gained durable strength as a result of the pandemic, but have not been fully rewarded by the market.

How has the fund performed?

Darren: The fund outperformed its Russell 1000 Value benchmark for the second quarter. From a longer-term perspective, the fund underperformed for the 1-year period but outperformed for the 3-, 5-, and 10-year periods ended June 30, 2021.

What is your view on the rally in value stocks that began late last year?

Darren: The outperformance of value stocks has certainly been a hallmark of this year. The rally began in full force in November 2020, sparked by the announcement of impressive efficacy results in Pfizer-BioNTech’s Covid-19 vaccine trials. Value stocks continued their strong run throughout the first half of 2021, fueled by the widespread distribution of vaccines, the reopening of economies, broadening global growth, and significant government stimulus.

What distinguished the rally recently, however, was an emphasis on cheapness over quality. This tends to happen with a recovery trade at the start of a new cycle. Enthusiasm over an economic rebound leads to a sharp style rotation, and investors flock to the cheapest stocks, often with little regard for company fundamentals.

In our view, that cheapness rally has evolved into a more durable value rally. True value rallies tend to be counted in quarters and years, not in weeks or months. That quick recovery trade — which favored almost any stock that was cheap — seems to have played out for the most part.

You’ve described financials as “the epicenter of earnings uncertainty in 2020.” What is your perspective on the sector now?

Lauren: Financial stocks were among the best performers in the first half of 2021, especially the large banks that had struggled considerably early in the pandemic. We believe their outperformance is due to a few drivers. First, financial stocks remained very cheap relative to the broader market. Also, it appeared there would be far less permanent damage to their loan books as a result of the pandemic. In 2020, banks took an unprecedented level of reserves against their loan books in anticipation of loans that could go bad. Banks have also benefited from rising bond yields, which allow them to charge higher rates on mortgages and other types of loans.

Where else are you finding opportunities?

Lauren: We are focused on businesses that gained durable strength as a result of the pandemic, but have not been fully rewarded by the market, in our view. This includes retailers that expanded their market share and generated extra cash flow from increased sales in 2020, but whose long-term potential has not yet been recognized by most investors. Like many value investments, these holdings require a measure of patience, and we are maintaining our positions in them.

As we enter the second half of 2021, what is your outlook?

Darren: As the second quarter came to a close, the bullishness in the market seemed more tempered. Earnings growth comparisons to early 2020 will soon be gone, and we are facing some new headwinds, such as inflation and worries that the Federal Reserve might shift from its dovish stance.

The market is still adjusting to a post-Covid environment. Many businesses benefited from pandemic-induced changes. Some of those benefits will be lasting, but many are transitory. We are focused on those companies we believe have lasting advantages as well as fundamental strength and solid return potential over the long term. We are shifting out of stocks that have hit our valuation targets, and we are redeploying those assets into stocks that many investors have overlooked. We often find opportunities when the market is too myopically focused, or apathetic, or simply misinterpreting a company’s fundamental value.