How Investors Can Find The Right Kind Of Value Stock


Credit Suisse U.S. equity strategist Jonathan Golub has been among the most bullish on Wall Street, but today he warned investors not to underestimate inflation pressure,

“Yesterday, the Bureau of Labor Statistics reported 7.5% CPI YoY, 0.2% above the consensus estimate. This follows two very powerful trends: (1) persistently increasing prices, and (2) persistently underestimated inflation readings. Investors Tend to Anchor on Previous Inflation Trends 10-year Treasury yields peaked at 15.8% in 1981, reflecting a decade of heightened inflation levels. What investors missed at that time was that inflation had already begun a precipitous collapse, falling from 14.8% in 1980 to 2.6% in 1983. While inflation flatlined from 1983 to 2020, bond investors remained anchored to previous inflationary trends for several decades. This is the best example of investor anchoring that we’ve ever come across. Forecasted Inflation Declines Too Optimistic Today, investors and policy makers remain anchored to lower inflation, with consensus expectations for a decline in CPI to 2.9% by year-end. While we remain in the long-term disinflationary camp, we believe that the economy will be plagued by greater-than-expected inflation throughout the current business cycle.”


Mr. Golub invented the clever phrase “transitory for longer” a while back.

“Jonathan ‘transitory for longer’ Golub warns investors not to underestimate inflation” – (research excerpt) Twitter

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BofA commodity strategist Francisco Blanch sees inventory shortages throughout the materials complex,


“Inventories are low, not just in exchange warehouses, but through the entire supply chain. As such, we think that there is limited safety buffer in the system. We also believe that, given the recent supply issues, market participants may prefer to run with higher stocks going forward. As such, we estimate restocking could add between 2ppt and 8ppt to demand in the coming years. To put this into context, average copper demand growth has been just over +2% in the past decade … Aluminium: Beyond strong / recovering demand, low inventories through the supply chain have also created concerns over supply. Indeed, even as China’s aluminium smelters were forced to cut production last year over emissions and tight energy markets … Copper: supply has also faced headwinds. Indeed, Chile’s output fell by 1% YoY in 2021, while Peru’s output has still been hovering around the longer-term average only, so we see further upside to prices into mid-year… "


“BofA notes low materials inventories across the complex”


Also from BofA, quantitative strategist Savita Subramanian (whose reports I’ve been mentioning a lot lately, but not by design) described the difference between promising value stocks and ‘value traps’,


“We are bullish on Value and expect Value to outperform Growth in 2022. However, not all Value stocks are created equal: while our fwd P/E factor (bottom 50 S&P 500 stocks by fwd P/E) has performed largely in-line with the index since 1997, Value Traps underperformed by 4ppt/yr during the same period (Exhibit 1). We define Value Traps as industries that are inexpensive for wrong reasons: prices falling with deteriorating earnings (see Methodology). At the end of January, Interactive Media & Services (e.g. FB, GOOGL) screened as a Value Trap for the third straight month (since Nov. 2021), and is -11% since then (vs. -2% for the S&P 500). Independent Utilities also screens as a Value Trap currently. We also believe it is too early to buy Growth … We prefer Value stocks with strong free cash flow, inflation protection, and improving fundamentals, such as Energy, which remained #1 in our tactical sector framework for the eighth straight month (and 12 out of the last 13 months), with top scores in all three variables we track (Table 5). Select industries within Health Care and Materials, along with Semis (which should benefit from rising capex/automation) also screen as “Opportunities,” a strategy which outperformed by 4ppt/yr since 1997 (Opportunities = above-average ranks in valuation, price momentum and earnings momentum).”


“BofA: “We prefer Value stocks with strong free cash flow, inflation protection, and improving fundamentals””