As developed markets recover from the global financial crisis, correlations between value, momentum, and risk are changing, and investors will need to come to grips with those changes to get the most out of their portfolios. Fortunately, value and earnings momentum strategies both stand to benefit from these changing correlations.

Correlation between Value and Risk has been coming down

“Ex-post correlation between Value and Risk has gradually been coming off its highs as macroeconomic risk has fallen – i.e. Value is less driven by macro/the Risk trade,” writes Citi analyst Chris Montagu. “Estimates Momentum is uncorrelated to Value and is now being driven equally by both cheap and expensive ends of the Valuation spectrum.”

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“This would perhaps imply stronger earnings momentum and increased earnings certainty across cheap Value stocks which should be a positive for both Estimates Momentum and Value styles,” writes Montagu.

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Macro effects no longer dominant driver

The Citi report also found that Macro effects are no longer the dominant driver behind equity returns, and investors can benefit from active stock picking strategies, and both value and estimate momentum strategies have the potential for strong returns right now. But unlike the last fifteen years, the country effect is more important than the sector effect. “This implies there are greater opportunities for cross-region stock selection than intra sector,” writes Montague.

Value has been outperforming the rest of the market for most of the year, resulting in low valuation dispersion. This makes it difficult to pursue a pure value strategy right now, and some value investors might even decide to wait for better opportunities to crop up. Even some equity bulls have recently recommended that investors looking for investment opportunities wait for a pullback caused by tapering, another political fight over the budget or debt ceiling, or some other catalyst before putting fresh money into the market.

Unsurprisingly, emerging markets are a different matter, and there still exists a higher level of PE dispersion with lower correlations in EM equity markets. Many investors have pulled money out of EM equities over the last year, but if the multiple expansion in DM markets has played itself out this could be a good time to consider reinvesting in emerging markets.