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Quant Strategy Value Stocks Back in the Spotlight

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Quant Strategy Value Stocks Back in the Spotlight Quant Strategy Value stocks back in the spotlight Rising interest rates make value stocks attractive In the DCF model, high interest rates mean deeper discounts of future cash flows. This Quant Report means that growth stocks should lose their luster relative to value plays when interest July 2, 2013 rates are rising. We expect investor interest will shift to value plays from growth stocks as the Fed appears to be switching to a tightening cycle, which should push interest rates higher down the line. Daewoo Securities Co., Ltd. Cyclical plays now pass for value stocks in Korea Quantitative Analysis In the past, cyclical stocks were usually growth stocks, while defensive stocks were Won-sun Lee considered to be value plays. But, under the current circumstances, many cyclical plays +822-768-4130 now belong to the value-stock category in Korea. For example, cyclical stocks in auto, [email protected] materials, and industrial materials sectors now pass for value plays. As Vanguard will complete its benchmarking adjustments in July, and Korea has become a developed market, we expect equity funds to focus largely on large-cap value stocks. Hence, we expect large-cap cyclical value stocks will fare better in July. In terms of P/E valuations, we like SeAH Steel (4.8x), Kia Motors (6.4x), Samsung Electronics (6.6x), Daelim Industrial (6.8x), Industrial Bank of Korea (6.9x), and Hyundai Motor (6.9x). And in terms of P/B, Woori Financial Group (0.4x), Hyundai Steel (0.5x), Hana Financial Group (0.5x), SeAH Steel (0.5x), Daelim Industrial (0.6x), and Hyundai Heavy Industries (0.6x) appear attractive. Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. July 2, 2013 Quant Strategy Value plays merit attention as interest rates are on the rise In the DCF model, high interest rates mean deeper discounts of future cash flows. This means that growth stocks should lose their luster relative to value plays when interest rates are rising. We expect investor interest will shift to value plays from growth stocks as the Fed appears to be switching to a tightening cycle, which should push interest rates higher down the line. <Figure 1> illustrates the relative strength of value plays against growth stocks in the global stock market. Since the global financial crisis, growth plays have largely prevailed over value stocks, riding ample liquidity, which has been the product of central banks’ monetary easing. However, value plays have begun to outperform growth plays in recent months, likely reflecting growing expectations for higher interest rates. Figure 1. Value vs. growth stocks in the global stock market (p) (1/01=100) 480 MSCI ACWI (L) 125 Value/Growth (R) 430 120 380 115 330 110 280 105 230 100 180 130 95 80 90 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: Thomson Reuters, KDB Daewoo Securities Research Korea’s stock market is not an exception: value stocks tend to outperform when interest rates start to rise. From June 2011 to February 2012, however, value stocks beat growth stocks for a different reason: risk premiums shot up due to the US credit rating downgrade. From June, value stocks started to outperform once again after a 15-month losing streak against growth plays. In Korea, value stocks tend to show strong momentum when the market recovers from an external shock, which drives up risk premiums and discount rates. Now, Korea’s stock market has just begun to recover from “the Bernanke shock” and interest rates are on a secular rise. This should set the stage for a period of outperformance by value stocks. Figure 2. Value vs. growth stocks in the Korean market (p) 3Y KTB (L) (1/08=100) 6.5 Value/Growth(R) 170 6.0 160 5.5 150 5.0 140 4.5 130 4.0 120 3.5 110 3.0 100 2.5 90 2.0 80 1/08 7/08 1/09 7/09 1/10 7/10 1/11 7/11 1/12 7/12 1/13 7/13 Source: Thomson Reuters, KDB Daewoo Securities Research KDB Daewoo Securities Research 2 July 2, 2013 Quant Strategy Figure 3. Value stocks in Korea have gained strength after market plunges (p) MSCI Korea (L) (1/97=100) 600 Value/Growth (R) 160 500 140 400 120 300 100 200 80 100 60 0 40 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Source: Thomson Reuters, KDB Daewoo Securities Research The Japan case The Bank of Japan largely adopted expansionary monetary policies In the 1990s. But when the central bank suspended its easing stance from October 1993 to March 1995, the 10-year JGB yield rose. And value stocks outperformed growth stocks during periods of high interest rates. In particular, cyclical plays in chemical, steel, machinery, auto, and IT sectors fared better. By that time, cyclical stocks had become synonymous with value stocks as cyclical stocks showed little growth along with the slumping economy. Figure 4. Value stocks strengthened in line with a rise in interest rates in Japan in 1994 (%) (1990=1.0) 5.0 10Y JGB yield (L) 1.00 Large-cap growth/Large-cap value(R) 4.5 4.0 0.95 3.5 3.0 0.90 2.5 2.0 0.85 1.5 1.0 0.80 93 94 95 96 97 Source: Thomson Reuters, KDB Daewoo Securities Research Figure 5. Relative performances of sectors in Japan in 1994 (%p) 30 25 20 15 10 5 0 -5 -10 -15 IT Gas F&B Steel Retail Value Media Travel Banks Leisure Growth Medical Telecom Insurance Electricity Securities Machinery Chemicals Oil refining Automobile Construction Personal care Personal Transportation Textile & apparel Notes: “Growth” = large-cap growth plays; “Value” = large-cap value plays Source: Thomson Reuters, KDB Daewoo Securities Research KDB Daewoo Securities Research 3 July 2, 2013 Quant Strategy Developed markets are more sensitive to discount rates In June, value stocks outperformed in developed markets, while growth stocks did better in emerging markets. Developed markets are more sensitive to discount rate changes due to their relatively low growth. The equation V = E/(K-g), where V is enterprise value, E is earnings, K is discount rate, and g is growth rate, might help explain this phenomenon. Korea is now showing the characteristics of a developed market: value stocks outperformed in June. Figure 6. Relative performances of value/growth stocks (1M) Figure 7. Relative performances of value/growth stocks (3M) Russia Russia Germany India China Brazil Brazil China Hong Kong Japan India Hong Kong Strengthening of Japan Germany growth stocks Strengthening of EM growth stocks EM UK Taiwan Taiwan Mexico World UK DM Strengthening of World Mexico value stocks Korea France France Korea DM Strengthening of (%p) (%p) US US value stocks -2-101234 -4-2024681012 Source: Thomson Reuters, KDB Daewoo Securities Research Source: Thomson Reuters, KDB Daewoo Securities Research Cyclical plays have become value stocks in Korea In the past, cyclical stocks were usually considered growth stocks, while defensive stocks were considered to be value stocks. But, under the current circumstances, many cyclical plays now belong to the value-stock category in Korea. For example, cyclical stocks in auto, materials, and industrial materials sectors now pass for value plays. Cyclical stocks and defensive stocks traded at similar P/B levels until 2012 (except during the 2008 global crisis). However, cyclical P/Bs have been falling behind defensive P/Bs since 2011 as earnings growth momentum has weakened <Figure 8>. Cyclical stocks account for 86.7% of the 30 KOSPI 200 names with the lowest P/Bs as of June <Figure 9>. They also make up 86.7% of the KOSPI 200’s low P/E stocks. Cyclical P/Es have long been lower than defensive P/Es <Figures 10 and 11 >. Bond yields appear set to trend up despite some short-term volatility as the Fed will eventually tighten its grip on money supply. This means value stocks will prevail over growth stocks for some time to come. KDB Daewoo Securities Research 4 July 2, 2013 Quant Strategy Figure 8. 12-month forward P/Bs of cyclical and defensive Figure 9. % of cyclical stocks among the KOSPI 200 stocks with stocks the lowest P/Bs (30 stocks) (x) Difference (defensive - cyclical) (%) 2.5 Cyclical stocks 100 % of cyclical stocks Defensive stocks 90 2.0 80 1.5 70 60 1.0 50 0.5 40 0.0 30 06 07 08 09 10 11 12 13 09 10 11 12 13 Note: Based on KOSPI 200 companies Source: WiseFn, KDB Daewoo Securities Research Source: WiseFn, KDB Daewoo Securities Research Figure 10. 12-month forward P/Es of cyclical and defensive Figure 11. % of cyclical stocks among the KOSPI 200 stocks stocks with the lowest P/Es (30 stocks) (x) Difference (defensive - cyclical) (%) 20 Cyclical stocks 95 % of cyclical stocks Defensive stocks 18 16 90 14 12 85 10 8 80 6 4 75 2 0 70 07 08 09 10 11 12 13 09 10 11 12 13 Note: Based on KOSPI 200 companies Source: WiseFn, KDB Daewoo Securities Research Source: WiseFn, KDB Daewoo Securities Research <Figure 12> shows how value and growth plays perform under different scenarios. If the economy is anticipated to improve and yields are also expected to rise, stocks in section A are preferable. If only bond yields are considered, both section A and B appear attractive. However, even in this case, since stocks in section A display lower P/Bs or P/Es than those in section B, stocks in section A look more attractive.
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