Despite the recent market rally and rotation from defensives into cyclicals, don’t give up hunting for value in the market, it can be found; that’s according to January 12 Global Equity Strategy note from analysts at Jefferies.
According to the note, a copy of which has been reviewed by ValueWalk, analysts at Jefferies calculate around 23% of global stocks with a market capitalization of $500 million or more still trade below 1.25 times price-to-book and 33% trade below a forward P/E of 15 times.
Jefferies: The Conditions Are Right for Value To Outperform
Buying value is what Jefferies is recommending for the year ahead. The bank’s analysts are highly optimistic about the outlook for earnings. As a result, value stocks should spring back into life.
Specifically, the analysts note that first half earnings estimates have slowly become ‘less bad’ as Wall Street begins to take account of a global inventory restocking, which has cast a dark shadow over cyclical companies for some time. The completion of this destocking should mean that those companies which benefit from operational and financial leverage (usually manufacturing and industrial) produce a better earnings profile.
To put it another way, this analysis hints at the idea that value stocks, which are generally cyclical industrials, may see higher earnings revisions over the next six months. Improving economic data and rising inflation expectations add to the optimistic outlook.
“We have argued that a combination of a change in inflation expectations and poor positioning (negative term premiums) have encouraged an unwinding of the quality, yield theme in favor of low PE and low PB stocks. Alongside the above two factors, the global economy has been dealing with a conventional ‘Kitchin Cycle’ or inventory overhang. Helped by China destocking this too seems to be ending. With China PPI indices having firmly turned positive alongside US final good prices that are back in the black, the jump in oil prices in 4Q has helped buoy inflation expectations. The bond bubbles have slowly burst from 3Q as economic data has improved and recession fears have receded. The last one to erupt has been in China. A grinding inventory reduction and improving shipments have helped global manufacturing to revive. In turn, this has helped earnings numbers to improve. FY1 (a proxy of FY2016) estimates have slowly become ‘less bad’ while FY2 (a proxy of FY2017) hence are just about to inflect positively after six years of contraction (see RHS chart). This should mean that companies that benefit from operational (and financial leverage) should produce a better earnings profile. Hence, it is quite possible that stocks that might trade on low PB or PE and be considered as value could equally be experiencing some of the best earnings revisions.”
The takeaway from Jefferies’ note is clear: it’s time to buy value.