February 14, 2023
Market Snapshot: What Do Cheap and Expensive Stocks Have in Common?
- In January, the cheapest decile of stocks ranked on price-to-earnings outperformed by 3.4% on average, while the most expensive decile outperformed by 10.9% (see chart). Outperformance of both the cheapest and most expensive stocks is rare and usually occurs during risk rallies in periods of economic uncertainty. The average of the top and bottom decile outperformance in January was 7.2%; we have only seen bigger moves in extreme P/Es in 2001-2002, 2009 and 2020, which were during or right after a recession.
- This phenomenon occurs in extreme “risk on” markets because both cheap and expensive stocks tend to be substantially more volatile than average stocks. In January, unlike in periods like the ones mentioned above, there did not appear to be an economic turning point. For instance, the unemployment rate was at a 53-year low of 3.4% and initial claims were under 200,000, less than one-third of prior levels.
- Meanwhile, traditional factors that do not have a risk bias (including some value factors, most fundamental factors, some earnings factors, and many technicals at this point) have underperformed. Companies missing earnings and revenue forecasts outperformed by over 5% in January (usually they underperform by over 5% per quarter), while companies beating estimates have underperformed by 2%. Quality metrics, estimate revisions and even projected growth, which tends to lead in growth-driven rallies, have been left in the dust. This leads us to conclude that January was more of a “junk” rally than one driven by improving fundamentals. Historically, these types of rallies are short-lived and provide strong entry points for active management.
Views expressed include opinions of the portfolio managers as of January 31, 2023, based on the facts then available to them. All facts are gathered in good faith from public sources, but accuracy is not guaranteed. Nothing herein is intended as a recommendation of any security, sector or product. Returns represent past performance and are not guarantees of future results. Actual performance in a given account may be lower or higher than what is set forth above. All investment has risk, including risk of loss. Designed for professional and adviser use.