​As Sam Sees It: Why Investors May Be Finding Value in the Unlikeliest of Places

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.

EQ: The Fed released its latest policy statement Wednesday, and what seemed to catch the market’s attention was that inflation is nearing its 2% target. What potential implications could that have on its approach going forward?

Stovall: I think that the Fed wants to see inflation hit its target. The Personal Consumption Expenditures (PCE) index is at 1.9%, year-on-year, which is still below the Fed’s target. The statement does say that the Fed sees inflation rising but does not think it will become a problem in the intermediate term. So, it seems as if they’re going to continue with their slow and transparent rate-tightening program.

We’re still sticking to the likelihood that there will be three rate increases in 2018. I don’t think the most recent statement leaned more hawkish or more dovish than the prior one. It basically said that the economy is doing what the Fed thinks it’s going to do, and they’ll continue to raise rates in that very gradual fashion.

EQ: Were you surprised that there was no mention in the statement of the trade tensions and the potential impact it may have on the economy? Could they be holding that discussion for the next statement, which is highly anticipated to come with another rate increase and press conference?

Stovall: I guess they don’t want to be commenting on something that hasn’t really happened yet. They will comment more, I think, on how it affects the data because they have to anticipate what the data is going to be and see what kind of changes there could be to GDP growth. Perhaps, because of the trade tensions, that would also keep the Fed from raising a fourth time in 2018 since they don’t want to get too aggressive and give the market another reason to remain weak.

EQ: The sell in May period is here. Last week, we discussed the sector rotation strategy into the more defensive areas for the coming six months. As you pointed out in this week’s Sector Watch report, investors have been doing just that. In addition, they’ve also been moving into the value areas. What does this tell us about the current market and investor sentiment?

Stovall: It tells me that investors are cautious, that they believe the good earnings growth was already built into share prices, and now with the Q1 earnings reports, they’re simply getting the confirmation of that forecast.

The market seems to be treading water. We are mapping out a series of lower highs, which is not a favorable indication. Around the 2,550 to 2,575 area on the S&P 500 is a very important line in the sand, if you will, below which I think the market could end up dropping more precipitously.

Because of that, I think investors are trying to play it safe. They are gravitating toward the more defensive areas because they want to stick with stocks and don’t want to bail out altogether. At the same time, they see greater value on the value side of the equation, as well as in some of the defensive sectors.

EQ: Investing in the growth areas—particularly the high momentum groups—has been the predominant trend of this current market. As you noted, growth investing has historically outperformed value investing—albeit with significantly more volatility. Since 1975, the Growth group has posted a 10.6% CAGR versus the Value group’s 9.2% CAGR, but with 30% more volatility. Are the value groups actually presenting value opportunities at these current levels or are investors just becoming more nervous that growth may have gone too far?

Stovall: No, I think some of the value areas—in particular, the value index—are showing attractive levels. In terms of earnings growth, the value side is expected to post a more than 19% increase in 2018, and the P/E ratio at 14.4 is a lot more attractive than the 19.7 for the growth side of the equation. So, I think investors are, in a sense, going to where there is some value, and obviously, the current spread is very wide between the two groups.

Other areas of the market that have been beaten up are Consumer Staples, Financials, and Telecom Services, but they have not done what a lot of investors would’ve hoped. So, I think it does represent some value in those areas.

EQ: Interestingly, you also screened for value stocks with high CFRA STARS ratings, however, they were mostly from the more cyclical groups. What do you think the reason is for that?

Stovall: First off, looking at CFRA’s ETF research, we find that all sectors have representation within the value side of the equation. Financials are the largest at almost 25% and were represented in the screen results. We had two stocks from Financials that came up in that screen. We also had two from the Industrials side, and Industrials represent about 10% of the value index. Materials had a relatively high exposure in this list of stocks that I screened for, and one point of interest is that Materials in the value side of the equation is twice as large as the Materials representation in the entire S&P 500.

You might have thought we’d see more in Consumer Staples, maybe more in Health Care and the like, and that we would end up probably not seeing companies in Tech. Yet in this index, we find that Technology does represent about 7%. So, there is some exposure there as well. I guess we have to look to what the analysts are saying they favor within the value side of the equation, and yes, they were not from your usual suspects.

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