Widening valuation spreads offer “significant” rally potential

Light at the end of the tunnel

Portfolios built around value-based positions may be primed for a “significant” rally following the sustained global stock market slide, according to strategists at Man Group.

The dramatic downturn following the Covid-19 outbreak has driven valuation spreads wider across a range of sectors, suggesting a “light may be appearing at the end of the tunnel for value investors”.

Specifically, recent data suggests US large cap industry- and sector-neutral valuation spreads have surpassed levels seen at the peak of the Global Financial Crisis, while spreads in small caps have also gapped out markedly, though not to the same extent, Man observed in a note on Tuesday.

“The wider the valuation spreads, the higher the likelihood of a significant value rally,” strategists at Man said.

Though tactical positions in value trades – where a stock is considered underpriced according to fundamental analysis – helped stem losses for some strategies during the final quarter of last year, recent years have generally proved tricky for value investing, with the early months of 2020 proving “even more challenging.”

However, analysis of historical data charting spreads between value and momentum trades – positions which capitalise on existing market trends, either upward or downward – suggests a shift into value stocks may, at this point, be premature, Man analysts observed.

“History shows that a rally in value usually occurs when there is a cluster of triggers. We are yet to see a similar cluster in 2020,” they said.