- Stocks that are considered undervalued are trading at a record cheapness compared to the rest of the market, says Marko Kolanovic, JPMorgan’s global head of macro quantitative and derivatives research.
- He foreses a so-called squeeze higher for value stocks, and recommends that investors position their portfolios to profit from a rotation away from popular growth names.
- Click here to sign up for our weekly newsletter Investing Insider.
- Click here for more BI Prime stories.
The coronavirus-induced crash was unkind to many portfolios — and especially to investors who pride themselves in buying stocks that the broader market ignores.
Value stocks that are beloved for their cheapness relative to strong fundamentals were cast by the wayside in favor of their more expensive peers in growth industries. After all, the latter — predominantly tech companies — were big beneficiaries of the sudden need to move several in-person activities online.
The end result is that value stocks are now trading at record cheapness relative to growth, says Marko Kolanovic, JPMorgan’s global head of macro quantitative and derivatives research. His takeaway from this trend is that value stocks are susceptible to a squeeze higher, and investors should rightly position their portfolios ahead of time.
There was a similar rush for the entrance doors in May and early June. At that time, shares of airlines, cruise lines, and other industries hardest hit by COVID-19 significantly outperformed others like healthcare and utilities.
However, this rotation turned out to be short-lived. To wit, the JPMorgan US Value Factor exchange-traded fund has gained 45% since the mid-March market bottom, while the comparable momentum factor ETF that hosts several growth stocks is up 53%.
This discrepancy between value and growth persists even as parts of the economy are recovering from the lockdowns imposed earlier this year. But history suggests this very moment is when value should be shining; it outperformed the growth factor for at least three months in 14 of the last 14 recessions when the economy started showing signs of improvement, according to data compiled by Bank of America.
To explain why value stocks remain downtrodden, Kolanovic points out that investors are worried about the surge in COVID-19 infections in some parts of the US and the possibility that Vice President Joe Biden will win the presidential election. These two things are considered risk factors to the recovery because one could slow the economy while the other could disrupt the policy status quo.
“We think the market is not properly pricing either of these events (assigning too much certainty to both),” Kolanovic said about investors’ concerns.
He quipped that new coronavirus cases in the southern and western US are unlikely to result in similar rates of mortality that were observed in the northeast earlier this year.
“An inflection in COVID-19 trends in the US South, repricing of election risks, positive vaccine news, additional US fiscal stimulus round, and/or better than expected Q2 earnings results/guidance could provide a catalyst for a squeeze on Value names,” Kolanovic said.
He further provided the following three trading ideas using options:
1. Buy Russell 2000 outperformance options on a value rotation, growth rebound, and potential short squeeze.
“Despite its underperformance, the Russell 2000 continues to display high correlation to the S&P 500 (~95% over the past year), making outperformance options relatively inexpensive and allowing investors to cheaply position for a rebound in small vs. large cap performance through these defined loss structures.”
2. Add value exposure via outperformance calls on value basket.
“Investors can position for the convergence of Value and the market in a protected manner via outperformance calls on a Value index vs. the market. For example, buy a 3M ATM call on the outperformance of the J.P. Morgan iDex Value index (JP1BVLL) over the S&P 500, contingent on the S&P 500 finishing higher, for 3.5% of notional, indicatively.”
Real Life. Real News. Real Voices
Help us tell more of the stories that matterBecome a founding member
3. Buy single-stock calls on value names with inexpensive earnings volatility.
Subscribe to the newsletter news
We hate SPAM and promise to keep your email address safe