The often overlooked segment of large-cap value stocks is primed for a significant resurgence, according to a recent report by Bank of America. Strategist Savita Subramanian emphasized the potential shift in market dynamics in a recent note, highlighting the potential for value stocks to outperform their growth-oriented counterparts.
Subramanian asserts that after a prolonged period of underperformance, value stocks—long overshadowed by the rapid rise of AI-driven growth stocks—are positioned to make a comeback. “After two decades of steady underperformance, US value may outperform growth again,” she stated, identifying three key scenarios where value stocks could shine.
Bank of America anticipates a broad-based increase in earnings growth across the S&P 500 by 2025. This expectation is driven by a shift towards efficiency among corporations, following a decade of underinvestment and low-quality earnings, exacerbated by inflation. The bank believes this trend will spread earnings growth beyond the usual tech giants. “Value sectors starved for capital, such as energy with newfound capital discipline and financials with stronger balance sheets and better lending capacity, should be rewarded as earnings growth catches up,” the report noted.
Economic Hard Landing
Value stocks could also gain an edge if the economy experiences a hard landing. In such a scenario, growth stocks would likely suffer sharp declines, prompting a relative outperformance of value stocks. Bank of America highlighted the current high equity allocations and suggested that a rising probability of recession would cause investors to shift from equities to bonds, disproportionately affecting growth stocks over value stocks.
Higher Interest Rate Environment
In a landscape characterized by sustained higher interest rates, value stocks are expected to benefit significantly. Bank of America pointed out that US value stocks have lagged behind growth stocks by a staggering 230% in the low-interest-rate environment driven by globalization, technological advancements, favorable demographics, and low debt burdens. The bank suggests that a world of structurally higher rates and inflation will bolster value stocks, potentially leading to an annualized outperformance of five percentage points compared to growth stocks.
For investors looking to capitalize on this potential shift, Bank of America recommends focusing on four value-oriented sector ETFs:
Utilities
Utilities ETFs (XLU, FXU) are currently valued attractively, with price-to-earnings ratios at their lowest since 2009 relative to the S&P 500. The bank notes that utilities, which control the essential power infrastructure, are crucial for realizing the potential of AI technologies.
Energy
Energy ETFs (XLE, OIH, MLPX) also present a compelling investment opportunity. The sector is considered cheap at both the sector and industry levels, with energy companies benefiting from tight markets and a renewed focus on capital discipline. Rising demand for energy services and the strong balance sheets of MLPs, along with access to constrained natural gas markets, further bolster the sector’s appeal.
Banks
Bank ETFs (KBE, KBWB) stand out within the financial sector. Bank of America’s research head for North American Banks, Ebrahim Poonawala, anticipates continued strong performance from mega-cap banks, with regional banks likely receiving a boost from greater certainty around Federal Reserve rate cuts.
Consumer Staples
Staples ETFs (IYK) are relatively inexpensive, reflecting concerns over consumer behavior. While Subramanian remains cautious on staples, Bank of America analysts see potential for increased food retail promotions in a hard landing scenario, which could boost volumes.
Key Takeaways
- Potential Shift: Large-cap value stocks, long out of favor, are positioned for a resurgence.
- Broader Earnings Growth: Corporations’ focus on efficiency is expected to drive widespread earnings growth.
- Economic Hard Landing: Value stocks could outperform growth stocks if the economy experiences a downturn.
- Higher Interest Rates: Sustained higher rates are likely to benefit value stocks more than growth stocks.
- Investment Opportunities: Utilities, energy, banks, and consumer staples are highlighted as attractive sectors.
Conclusion
Bank of America’s analysis points to a potential renaissance for value stocks, driven by broader earnings growth, economic conditions, and a higher interest rate environment. For investors, this could signal a strategic shift towards sectors and ETFs that have been undervalued in recent years, offering new opportunities for significant returns.
