There has been a lot of chatter recently about momentum stocks versus value stocks, thanks to a huge pivot that started in September. Specifically, investors are asking two questions — why did this pivot happen, and will it continue?
In short, it’s happening all because of the 10-year U.S. Treasury yield, and it will persist for the foreseeable future.
The logic is simple. Lower yields support momentum stock valuations by decreasing the discount rate on future profits, and thereby increasing the net present value of future profits. Theoretically, this should help all stocks. But, momentum stocks derive more value from future profits than value stocks, so lower yields disproportionally benefit momentum stocks. Thus, when yields move lower, momentum stocks outperform. When yields go higher, momentum stocks underperform.
The data is also simple. From January to May 2019, the 10-year Treasury yield was largely range-bound between 2.5% and 2.7%. During that stretch, the the iShares Momentum Factor ETF (BATS:MTUM) and the iShares Value Factor ETF (BATS:VLUE) both returned about 13%-14%.
From May to September 2019, however, the 10-year Treasury yield plunged from 2.5% to 1.5%. During that stretch, MTUM rose 6%. VLUE dropped 4%. Then, from September to November 2019, the 10-year Treasury yield rebounded to 2%, the Momentum Factors ETF fell flat, and the Value Factors ETF rose 11%.
In the momentum versus value debate, it’s all about yields. Thanks to an improving economic outlook, easing geopolitical tensions and a Federal Reserve that seems to be done with this rate-cut cycle, it appears that yields will keep rising for the foreseeable future. As they do, value stocks should continue to work.
With that in mind, let’s take a look a five strong value stocks that are worth buying as yields move higher.
Strong Value Stocks to Buy: Intel (INTC)
Percent Return Since September: 22%
First on this list of strong value stocks to buy as yields move higher is global semiconductor giant Intel (NASDAQ:INTC).
The bull thesis on INTC is simple. This is a value stock trading at a very reasonable 12.3-times forward earnings multiple, with a respectable 2.2% yield. Those are deep value characteristics, so as yields move higher and provide a boost to the whole value category, INTC stock should benefit from that boost.
At the same time, thanks to easing global geopolitical tensions, economic activity is starting to pick back up. This is especially true in the semiconductor space, which has been hit hard in 2019 but has shown signs of bottoming and reversing course over the past few months. That’s great news for Intel, whose data-centric business has been hit hard by slowing semiconductor demand over the past few quarters. But, much like the broader semiconductor space, Intel’s data-centric business rebounded in a big way last quarter. That has sparked a 22% rally in INTC stock since early September.
History says this is more than head-fake. Usually, if demand rebounds for several months following a multi-month streak of declines, it is the beginning of a big rebound in the semiconductor space. That’s exactly what we have today. Thus, over the next few quarters, semiconductor demand should continue to bounce back, and so will Intel’s data-centric business and INTC stock.
General Electric (GE)
Percent Return Since September: 40%
Next, we have beaten-up global industrial giant General Electric (NYSE:GE), which appears to be in the first few innings of staging a big comeback.
GE stock is up 40% since early September. That’s the biggest and most convincing rally this stock has staged in recent memory. Is it for real? Will the strength last?
Yes and yes, because this recovery is supported by internal and external improvements which should persist. On the internal front, management continues to do everything right to get GE back on track. The company is paying off debt and reducing leverage on the balance sheet, divesting non-core businesses and simplifying the business model, and cutting costs where necessary to improve profitability. Management has said that they will continue to do all these things until profit trends improve in a big way.
Meanwhile, on the external front, easing trade tensions are providing a lift to corporate confidence levels around the globe. This lift in confidence should provide a boost to presently depressed capital spending trends. As those spending trends rebound, GE’s numbers should improve, since this company is built on the back of industrial capital spending. At the same time, yields are moving higher, and that will help push this still relatively cheap stock higher.
Percent Return Since September: 23%
Specialty pharmacy retailer CVS (NYSE:CVS) has regained its groove over the past few months and should stay on a winning path for the next few months, too.
CVS stock is a value stock. At 10.6-times forward earnings with a 2.7% yield, this is the exact type of low-multiple, big-yield stock that investors think of when they think of value stocks. Thus, as value stocks continue to work thanks to rising yields, CVS stock should continue to work, too.
Meanwhile, the fundamentals here are also improving. For a long time, this was just another stagnant, non-innovative pharmacy retailer with sluggish traffic, sales and profit trends. But, CVS is finally starting to innovate across multiple verticals, including rolling out localized healthcare HealthHUB locations. This innovation is powering a rebound in the company’s sluggish traffic, sales and profit trends. So long as this rebound persists, investors will continue to push CVS stock higher against a favorable value stock backdrop.
A favorable backdrop and favorable fundamental improvements should continue to push CVS stock higher.
Percent Return Since September: 7%
Often considered the king of deep value stocks, telecom giant AT&T (NYSE:T) should naturally be a winner as yields rise and value stocks move higher.
There are two pieces to the bull thesis here. First, at almost 11-times forward earnings and with a 5%-plus dividend yield, AT&T stock is a prototypical deep value stock with a small multiple and a big yield. Those stocks tend to do well when yields move higher. AT&T stock is no exception. It’s up 7% since yields started powering higher in early September. This strength should persist so long as yields keep grinding higher.
Second, AT&T’s fundamentals are set to meaningfully improve in 2020. For the past several years, AT&T has been plagued by cord-cutting trends in its video business. This has weighed on revenues and profits, and ultimately kept T stock stuck in neutral from 2015 through 2018. But, AT&T is set to launch a new streaming service in 2020, HBO Max, and this new streaming service should help the company offset its cord-cutting problem with streaming subscriber adds.
This should provide a nice boost for T stock. Just look at what happened to Disney (NYSE:DIS). This, too, is a company which has been mired in cord-cutting headwinds over the past few years. But, Disney launched a new streaming service in 2019, and early success of that streaming service has pushed DIS stock 35% higher year-to-date to all-time highs.
The same could happen to AT&T stock in 2020.
Percent Return Since September: 25%
Last, but not least, on this list of strong value stocks to buy as yields rise is athletic apparel maker Skechers (NYSE:SKX).
For all intents and purposes, Skechers is a growth company. Just look at the numbers. Constant-currency revenues rose 17.2% last quarter, paced by a 25.7% gain in the international business. Comparable-store sales rose 7.7% in the quarter. Gross and operating margins expanded. And, last quarter wasn’t an anomaly. Since the start of 2018, Skechers’ average constant-currency revenue growth rate has been above 12%. The international business has averaged about 20% growth, comps have averaged about 4% and margins have consistently powered higher.
In other words, the numbers says Skechers is a growth company. But, SKX stock doesn’t trade like a growth stock. It trades like a value stock.
The forward earnings multiple on SKX stock? Just 15.6. That’s below the apparel sector’s average forward earnings multiple of 19, the consumer discretionary sector’s average forward multiple of 22 and the footwear sector’s average forward multiple of 28. It’s also well below where both peers Under Armour (NYSE:UA, NYSE:UAA) and Nike (NYSE:NKE) trade, and yet, Skechers is growing at a faster pace than both of those companies.
Broadly, then, Skechers is a growth company trading at a value stock valuation. That discrepancy implies a favorable risk-reward profile for bulls, especially in an environment where value stocks are set to move higher.
As of this writing, Luke Lango was long INTC, GE, CVS, T, DIS, SKX and NKE.