In our last post we highlighted a volatility spike in the Value / Growth ratio as a potential sign that the multi-year under-performance of Value might be coming to an end.
More specifically, we looked at the 10-day volatility of the MSCI Asia-Pacific ex-Japan Value index divided by MSCI Asia-Pacific ex-Japan Growth index, which in November spiked to 30 for the first time in twenty years.
The last time this happened marked the start of a long period of Value outperformance.
Volatility spikes are often associated with market turning points. Why? It could be because volatility represents uncertainty among market participants as to the fair price of securities. Any event creating greater uncertainty leads to lower bids and higher offers due to lower pricing confidence on both sides.
Wider spreads naturally mean higher price volatility. And in extreme cases, volatility rises to such an extent that it forces risk reduction. Risk reduction pushes spreads wider and volatility still higher in a positive feedback loop. This continues until the point at which involuntary risk reduction activity exhausts itself – and then the stage is set for a reversal.
In the broader market, we saw this pattern during the sharp coronavirus-led sell-off of March 2020, when MSCI Asia-Pacific 10-day volatility peaked at 61, exactly coinciding with an index turning point.
However in the case of the Value / Growth ratio, volatility only rose modestly during March, during which time Value stocks continued to underperform the rest of the market. This trend continued and even accelerated into November, which is when the volatility of the Value / Growth ratio finally peaked.
Since then, the “turning point” thesis has been working, with Value outperforming in December for the first time in many months. January is also off to a positive start.
We have analysed the factors why Value had been under-performing in previous posts. Are there any macro factors that can now sustain the nascent trend of out-performance?
One candidate is rising expectations for global reflation, driven by the successful development of coronavirus vaccines combined with massive ongoing fiscal stimulus in the US and elsewhere.
While the jury is still out as to whether reflation will definitively take root, if it does it will be very positive for Value-oriented strategies.