Is There Any ‘Value’ Left Here? Goldman Answers

Earlier today, we brought you another quick example that underscores the extent to which the trends that have dominated in 2017 have reversed over the past three weeks.

Specifically, we noted that the transports have begun to catch back up with the Dow, a development the bulls will invariably trot out as good news (and they may be right, for once).

The recovery in the transports is part and parcel of a broader reversal that’s been variously described as the return of the “Trump trade” or the revival of the U.S. reflation story. The impetus would appear to be the hawkish Fed and the notion that fiscal policy is finally moving forward after months of gridlock and infighting (alternative explanation from SocGen is here). We would suggest these hopes are misplaced. Tax reform will be an uphill battle (to say the least) and Trump has once again kicked off the weekend with a series of absurdly divisive tweets, this time taking aim at Puerto Rico on the way to all but telling Americans that what they’re seeing on television in terms of images from the island aren’t real.

But whatever the case, the reversals are real (even if they prove transitory) and another example of the rotation is the outperformance of value vs. growth. This is something Goldman flagged earlier this month in a note aptly entitled “what’s going on with tech?” Here’s an excerpt for those who missed it:

Rotation from Growth to Value starting to pick up after the spread widened to multi-year levels during 3Q. Tech is the best proxy for growth in the market — XLK daily returns are 95% correlated to Growth factor — so as this factor rotation picks up, it is worth watching the Tech sector as a ‘source of funds’ candidate (Financials and Energy are highly correlated to the Value factor).

Have a look at the following chart (first yellow highlight is the election):

Is this trend likely to continue? For their part, Goldman says probably not. Here’s the bank recapping the recent action, including what you see in the chart shown above:

Rising optimism for corporate tax reform has contributed to a recent reversal in the 2017 outperformance of growth stocks vs. value. Throughout much of 2017, investors rewarded growth stocks relative to value stocks (+19% vs. +4% through September 7th). However, improved prospects for fiscal stimulus have helped the Russell 1000 Value outperform the Russell 1000 Growth by 250 bp (+1% vs. +3%) since September 7th. Although the two Russell indices have substantially different sector weightings, a similar rotation to value from growth can be seen in our sector-neutral long/short value (GSMEFVAL) and growth (GSMEFGRO) factors (+3% and -1%, since September 7th, respectively).

But, Goldman thinks that you should curb your enthusiasm as it relates to value vs. growth even as rising rates should support the rotation. Here’s why:

Three macro variables drive the growth versus value trade: (1) interest rates, (2) economic growth, and (3) oil prices.

Value stocks typically outperform when economic growth is strongest. The US economy is at full employment and professional forecasts for average GDP growth in 2018 are clustered between 2.2% and 2.6%. Our US Economics team expects US GDP growth will average 2.4% in 2018. During similar periods of stable but unspectacular economic activity, investors have typically rewarded companies expected to grow sales regardless of the pace of GDP growth. However, if tax legislation is passed that lifts business investment, consumer spending, and broader economic activity, then value stocks could continue to outperform.

Our Commodities team expects the recent oil rally is unlikely to persist, further dampening the case for value stocks. Brent oil prices have increased to $57 from $50 in mid-August. The rise in oil prices has coincided with higher inflation expectations and interest rates and has contributed to the outperformance of the value strategy. Energy stocks, which account for 11% of the Russell 1000 Value index, have outperformed the S&P 500 by 8 pp during this time. However, the current Brent crude price is in line with our Commodity Strategists’ 12-month forecast, suggesting little additional upside. Last week our colleagues also noted that the Brent forward curve had become backwardated and that they expect this structure to persist.

A backwardated oil curve has historically been positive for Energy returns in the short term (since a curve often becomes backwardated due to a surge in spot prices) but can be a headwind in the longer-term as firms are forced to hedge future production at futures prices lower than spot.

Whatever the case, this is going to depend largely on whether the revival of hope in Trump’s agenda proves sustainable or whether it is, as usual, simply a “false start.”

And as we noted earlier this week, anymore false starts and it might be time to throw someone out of the game…

if this proves to be another "false start" on tax reform, well then we need to blow our referee whistle… pic.twitter.com/K9GRvdgHOY

— Heisenberg Report (@heisenbergrpt) September 28, 2017