Value investing has a long history of delivering above‑market returns but since the Global Financial Crisis, value‑oriented strategies have struggled as subdued economic growth, very low inflation and ultralow levels of interest rates have hindered performance.
This period has been highly unusual, but with the return of inflation and central banks implementing one of the fastest rate‑hiking cycles in history, we have seen a material evolution in the market environment back to a more normal one. The field is now much more even, offering attractive opportunities for value investors.
While there are parts of the value universe that are economically sensitive, such as banks and “highly cyclical” industrials, there is also a strong balance of defensive areas, such as health care, and companies that have strong pricing power, especially in traditional industries such as utilities and consumer staples where high inflation has clear benefits. Meanwhile, with supply chains being restored and the effects of deglobalisation and onshoring accelerating, we are expecting higher levels of capital expenditure going forward.
Having a global opportunity set that offers both cyclical and defensive attributes is attractive for investors seeking balance in their portfolios. We have identified three key areas where we see exciting opportunities going forward.
Energy prices supported by energy independence and transition
Energy prices are rising as geopolitical concerns increase, inventories are low, and the cost of capital has expanded. Oil prices have risen solidly since the summer trough as geopolitics have amplified the desire for energy security and independence, while rig counts in the US have fallen. Geopolitical events have focused investor attention on energy supplies.
Further, a lack of investment, especially in oil and natural gas extraction, has also caused prices to rise. The cost to pull energy from the ground has risen steadily due to the higher cost of financing, hiring and transportation. There are also some indications that the long-term trend of improving productivity is reversing. Meanwhile, with uncertainty surrounding weather patterns, higher energy prices are likely to persist, potentially improving returns for energy companies.
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Healthcare investment and innovation set to increase
The pandemic brought into sharp focus the critical importance of global healthcare investment, innovation and access. The pandemic prompted governments to increase capital flows across a range of industries to strengthen the resilience of global healthcare systems, and we anticipate that this will support a period of innovation, consolidation and optimisation.
Healthcare is an area that is consistently growing and developing. The sector has also displayed resilience during periods of market uncertainty, as the general inelasticity of demand for healthcare products and services has typically helped in times of weak sentiment. The bigger headwinds arise from factors such as patent expirations of blockbuster drugs, the success of development pipelines, and political risks relating to drug pricing, especially in the US. However, free cash flow generation remains strong in the sector, and we are encouraged by the drug pipeline, especially in areas of diabetes, Alzheimer’s disease and cardiovascular conditions.
Beyond the general defensive profile, there can also be controversies that present investment opportunities. More recently, doubts around accessing financing for biologics and life science companies in a regime of sharp monetary tightening have weighed on the performance of equipment suppliers.
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We also need to assess the impact of new GLP-1 drugs that could dramatically enhance weight loss. This has a potential knock-on effect on medical care companies and F&B companies. Many investors are also still concerned by the “coronavirus unwind” in different segments of the industry. Finding pockets of value in such environments, however, has shown to be successful over the longer term.
Expanding the opportunity set in technology
Many value managers tend to allocate minimal resources to finding opportunities within the information technology sector due to the high valuations and long duration that industries within the space can present. But opportunities can still be found, especially when sentiment turns against a sector and uncertainty is high. This is especially true in “cyclical tech” currently, which includes semiconductor and semiconductor equipment companies. We have made several investments in memory chip companies.
The cyclical nature of the tech sector arises from the nature of customer demand, investment and inventory patterns, and other competitive behaviours that can cause sharp swings in industry returns and profitability. During this volatility, opportunities can arise as investors try to avoid the downturn as the cycle deteriorates and the market overly extrapolates trends into the future.
The short-term fear of the unknown can therefore create an opportunity to unearth potential new investment candidates as the near-term reduction in market value is balanced with the potential intrinsic value of the company.
Importance of finding balance in a portfolio
Value investing has performed well in a range of different economic environments. While several factors have made investing more difficult in recent years, the classic value investing model has not fundamentally changed. Investing in companies that trade below their intrinsic value has continued to prove a successful strategy. Meanwhile, short‑term disruption, controversy, or setbacks in the market continue to cause equity mispricing.
With stock prices oscillating more than their underlying fundamentals, there are opportunities to take advantage of these mispricings and investors’ short‑term horizons. In today’s market, with high economic and geopolitical uncertainty, it is important to maintain a well-diversified portfolio across factors, styles and economic exposures.
Sebastien Mallet is a portfolio manager of the T Rowe Price Global Value Equity Strategy
