Value Stocks Have Contrarian Appeal

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By Bob Landry, CFA

Chief Investment Officer, USAA Investment Management Company


U.S. large-cap stocks have been strong performers so far in 2017. Through Tuesday, the Standard & Poor’s 500 index was up nearly 9% on a total-return basis. But that number might have a casual market-watcher wondering, “Really? Only 9%?”

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Such a perception gap could exist because news out of the equity market seems to be concentrated on a handful of the biggest and best-known names in technology that are posting year-to-date returns close to four times the S&P average.


A couple of these stocks are generating increasingly bold headlines as their price approaches $1,000 a share, with mind-boggling references to how much richer you would be now if only you were lucky enough to invest even a modest sum on their first day of trading (and smart enough not to sell during the many rough patches along the way). As a group, these high-fliers now include the four largest companies in the world by market cap.


Of course, the ride is exhilarating when a stock shoots up so high and so fast, but the higher and faster the trip, the more potential dangers of ownership.


We’re by no means suggesting these stocks or the tech sector overall (+20% YTD through May 26) are in imminent peril. We do think, however, that some caution could be in order for those tempted to chase the hot trend — some of the loftiest tech names are now priced around 200 times earnings. By comparison, the S&P 500’s P/E ratio is roughly 24x, itself a fair bit higher than the index’s long-term average.


Demand for growth-oriented stocks is being driven largely by sagging expectations for the U.S. economy. First-quarter real GDP growth has been revised up from an annualized rate of 0.7% to 1.2%, but equity investors have been searching for signs that the economy could exceed 3% real growth for a sustained period. When those signs fail to emerge, they seek out the stocks with the best growth prospects. And when the same names end up on everyone’s list, their prices are bid up into nosebleed territory.




Current conditions have been tough on value stocks, which tend to perform better when the economic outlook is brighter. With consumer spending in decline, the Federal Reserve in tightening mode and the White House’s pro-growth plans in doubt, it’s hard to see where any GDP tailwind would come from.


All this said, it might seem a stretch to suggest that now might be a good time to consider investing in value, but a case can be made for this contrarian approach.


First, because value stocks are so unloved these days, they are cheap relative to the S&P 500 as a whole. This means investors are paying less for every dollar of earnings being generated by these companies, and those dollars are increasing. Forecasts call for decent-to-good earnings growth at least through 2017. Cheapness may also help on the risk side by providing a measure of downside protection compared to higher-priced growth stocks.


Selectivity is also important. While value overall is underperforming growth, some value-oriented sectors have turned in above-average returns so far this year. These include utilities and consumer staples, which have benefited from investors seeking dividend income and from those taking a defensive stance as the stock market continues to hit new all-time highs in a weak macro environment.


In fact, most of value’s troubles can be traced to just two struggling sectors: energy (-13% YTD) and telecom (-10%). Financials are flat for the year, but stand to see improving fortunes as the Fed boosts interest rates and if tax cuts and/or reduced regulation pass muster in Washington.


We search for value globally, and now we see more opportunities in international developed markets, most notably Europe. Among other reasons, fundamental valuations are considerably lower in Europe than in the U.S., which could increase the upside potential. The region is also seeing a pick-up in GDP growth, albeit slowly and from a very low base. This momentum, if sustained, could create ripe conditions for value investors.





As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are suited for you based upon your individual goals, objectives, risk tolerance and time horizon.


Investing in securities products involves risk, including possible loss of principal.


This material is provided for informational purposes only by USAA Asset Management Company (AMCO) and/or USAA Investment Management Company (IMCO), both registered investment advisors. The material is not investment advice and is not a recommendation, an offer, or a solicitation of an offer, to buy or sell any security, strategy or investment product. The views and opinions expressed in the material solely reflect the judgment of the authors, but not necessarily those of AMCO, IMCO or any affiliates as of the date provided and are subject to change at any time. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but AMCO/IMCO does not guarantee its accuracy. The information presented should not be regarded as a complete analysis of the subjects discussed. Any past results provided do not predict or indicate future performance, which may be negative. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of AMCO/IMCO and USAA.


Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.


Investments in foreign securities are subject to additional and more diverse risks, including but not limited to currency fluctuations, market illiquidity, and political and economic instability. Foreign investing may result in more rapid and extreme changes in value than investments made exclusively in the securities of U.S. companies. There may be less publicly available information relating to foreign companies than those in the U.S. Foreign securities may also be subject to foreign taxes. Investments made in emerging market countries may be particularly volatile. Economies of emerging market countries are generally less diverse and mature than more developed countries and may have less stable political systems.


Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market.  S&P 500 is a trademark of the McGraw-Hill Companies, Inc.


Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers, and affiliates.


Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License # 0E36312), a registered investment advisor and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.



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