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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good morning. Unhedged was alarmed to read in the Financial Times that a cyber attack had shut down Asahi’s breweries in Japan. It’s one thing for cybercriminals to come after the financial system. But when they target our beer, it’s war. Send us thirst-quenching thoughts: unhedged@ft.com.
Value stocks
Right now, the US stock market loves growth, tech and volatility. You can see this in sector performance since the market’s “liberation day” low in April. Anything tech related is going absolute gangbusters (the AI giants are scattered among the tech, communications and consumer discretionary sectors). Cyclical stocks — industrials, materials and financials — are going great as well; rumours of faltering growth in the non-AI economy have not reached the ears of equity portfolio managers, apparently. The oil price is barely above $60 a barrel, and energy stocks are up double digits.
The laggards? Nice, safe, low-beta, defensive stocks such as healthcare and consumer staples. Utilities, which are having a nice few months, would have fit in this category a year or two ago, before energy-hungry data centres turned them into an AI play.
What is not quite captured in the recent sector performance is the underperformance of value stocks — essentially, stocks that are inexpensive on measures such as price/earnings or price/book ratios. But value’s performance relative to growth is historically weak. Here’s a 30-year chart of the relative performance of S&P 500 subindexes: value versus growth, high volatility versus low and equal weight versus market cap weight (as a measure of enthusiasm for a few super stocks):
It’s a stupendously strong trend. Why would you try to buck it? That chart shows why. Look back at the last time value (and low beta, and the equal weight index) hit a deep low, in the dotcom bubble. After that bubble bust, values outperformed strongly for years.
This is not a suggestion that anyone should try to catch the turn. Timing these things is impossible. Furthermore, part of the reason that value performed well after 2000 was that there was a recession that year, and in an economic recovery following a recession value stocks do well (they tend to be economically sensitive). And if we are heading for a recession, holding any sort of stock is going to be acutely painful for a little while.
The point, instead, is that long-term value is building up in value stocks, and investors with a long-term horizon should be thinking about what they will want to own in the next market phase.
Patrick Kaser of Brandywine Global Investment Management, one of Unhedged’s favourite value guys, says he starts value hunts by screening big companies for free cash flow/enterprise value yield (“enterprise value” is the value of a company including its debt). Here are the top 25 non-financial S&P 500 stocks on that metric.
Readers will have different views about the names on that list; the reason some stocks are cheap is that the underlying businesses are in trouble. But there are big companies out there selling for attractive prices relative to their cash flows, and some of them have very sound long-term prospects. Unhedged is particularly interested in some of the unloved healthcare, energy and industrial stocks on this list.
Jon Hartsel of Donald Smith & Co, pointed out to us that anything agricultural is under pressure, between higher input costs and tariffs and softish demand — see Archer-Daniels and CF on the list above. Kaser notes that there are several software companies, seen as potential losers from the AI revolution, have now fallen into value territory. Though not quite on the list above, Salesforce and Adobe have free cash yields of 6 and 7 per cent, respectively.
It feels like a good time to go value shopping.
One good read
The socialist states of America.
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Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.