It’ll Take a Recession for Value to Shine, Morgan Stanley Says

(Bloomberg) -- Value shares are set to bounce back from their 13-year underperformance against growth stocks, according to Morgan Stanley -- with the catch that recession will come midway through their rebound.

Value stocks will experience a two-phase recovery, strategists including Andrew Pauker and Mike Wilson wrote in a research report dated Nov. 14. Growth companies will firstly underperform amid earnings downgrades and rising cost of capital. That will culminate in a recession, after which strategies targeting cheaper stocks will outperform, the strategists said.

“Growth is less defensive than people think,” the strategists wrote. “The high cost of equity capital for growth stocks, driven by a rising beta and equity risk premium, poses an underappreciated near-term risk.” They added that “an economic downturn will be required to reset the capex cycle and drive large-scale fiscal stimulus.”

They stopped short of making a call on the timing of the next economic downturn, though see signs the first phase of the value rebound may have begun.

Strategies based on buying unloved shares trading on low earnings multiples have rebounded since September as signs emerge of an unexpected recovery in the U.S. and Germany, while the Federal Reserve has signaled it’s done cutting interest rates for the time being.

Some remain skeptical of the outlook for the approach after so many years of underperformance, but brokers including Societe Generale SA, Bank of America Corp. and Sanford C. Bernstein are recommending the value style of investment. In October, ETFs targeting value drew $3 billion of flows.

To contact the reporter on this story: Gregor Stuart Hunter in Hong Kong at ghunter21@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Joanna Ossinger, Teo Chian Wei

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