Second, investors have recently been focusing on the rebound in value stocks. While value as style has indeed done better as recession fears have faded, maintaining the rally will require value companies to demonstrate some improvement in depressed earnings and historically low profitability. That is much less likely in an environment in which manufacturing activity is still contracting. If the value rally is to continue, that will need to change.
In short, future gains in stocks depend on an upturn in earnings growth. In the meantime, investors ignore the manufacturing recession at their own risk.
Market Realist – For value stocks to rally, manufacturing activity needs to pick up
In the past few years, value stocks haven’t posted impressive gains. Many of them look cheap and have trailed the broader market as investors lap up growth stocks. According to Morningstar, heightened investor interest in growth stocks (GOOGL) (AMZN) pushed up the Russell 1000 Growth index 5.7% in 2015. That’s 9% higher than the Russell 1000 Value index. This was the highest gap since 2009. Similarly, growth stocks in the Russell 2000 index of small-cap stocks outperformed value stocks by 6%.
Value stocks rebounding
In recent months, the Market’s leadership seems to be changing in favor of value stocks. This is because growth stocks (NFLX) have become expensive, and future returns expectations are tepid. On the other hand, value stocks have become too cheap with expectations of higher gains in the next few quarters. This is amply clear from the fact that value stocks in the Russell 1000 index have risen 0.5% this year compared to a fall of 1.1% in growth stocks. Likewise, small-cap stocks in the Russell 2000 index are higher by around 6% over the growth stocks.
Weak manufacturing might be a hurdle
Although value stocks are rising, a strong sustainable rally might require a pickup in industrial (IYJ) activity and robust economic growth. Financial (IYF) (IYG) stocks, which comprise a large part of value indexes, would benefit from robust economic growth and higher rates that would push up the margins of many entities. On the other hand, a weak dollar coupled with a pickup in industrial activity would help manufacturing companies come out of their slumber.