The difference in how much corporates are compensating lenders over governments is shrinking, and the risk-reward in credit is broadly indicative of an impending cyclical rotation away from ‘safe’ assets. Taken together, these factors should be supportive of a broad-based cyclical rotation and value’s outperformance. However, it is the valuation of value that remains the cornerstone of the argument.
Given the current uncertainty and risk aversion fuelled by geopolitical tensions, the return to value looks to have been pushed out further for the time being. This means already wide valuation spreads continue to widen, providing a significant opportunity for longer-term investors. It would not take much for some form of mean reversion to occur – valuation alone could be the catalyst. History shows that when value reverts, it does so quickly and sharply.
Notwithstanding any economic shocks as markets start to function in a more ‘normal’ fashion, it is likely investors will continue to reassess the rich valuations of many quality stocks.
As the gap narrows, value should continue to outperform, albeit not necessarily in a straight line.
Ritu Vohora is investment director for equities at M&G Investments
