As the dog days of summer roll in, the financial market is on edge, with traders anxiously awaiting Federal Reserve Chair Jerome Powell’s address at Jackson Hole. This nervousness is not without precedent, given that Powell’s brief eight-minute speech last year is largely considered the catalyst for the stock market’s slump to October lows. With US inflation currently sitting at 3.2%, down from 8% this time last year, traders are left speculating whether Powell will adopt a similarly hawkish stance this year. His speech, scheduled for 10:05 a.m. Eastern, is expected to set the tone for the market.

In the midst of this uncertainty, Vanguard’s Capital Markets Model research team, helmed by Kevin DiCiurcio, suggests that investors might want to consider shifting their focus to value stocks. Defined as stocks with relatively low prices in relation to their enterprise book or accounting values, lower expected and historical growth rates, and relatively high dividend yields, value stocks may be a safe harbor in the potential storm. According to Vanguard, the relationship between value and growth is currently at an extreme level, mirroring the pattern observed in 2020. This, coupled with an apparent lack of interest in value stocks from investors, could present a contrarian opportunity.

Market Watch: Eyes on Powell, Value Stocks, and The Current Market Landscape

Powell’s Anticipated Speech

It’s a tense day in the trading world as everyone awaits Federal Reserve Chair Jerome Powell’s speech at Jackson Hole. Last year, Powell’s eight-minute speech was believed to have triggered a slump in the stock market, which lasted until October. With the U.S. inflation rate currently sitting at 3.2%, down from 8% a year ago, traders are keen to see if Powell will adopt a similarly hawkish stance this year.

The Case for Value Stocks

In the midst of this anticipation, Vanguard’s Capital Markets Model research team, led by Kevin DiCiurcio, is encouraging investors to consider switching to value stocks. Defined by Vanguard as stocks with lower prices relative to their enterprise book or accounting values, lower expected and historical growth rates, and relatively high dividend yields, value stocks are currently in a similar position to last year.

According to DiCiurcio, investors are currently very enthusiastic about growth stocks, particularly technology shares, and show limited interest in value stocks such as those in the financial, industrial, and healthcare sectors. This extreme is reminiscent of 2020 and could present a contrarian opportunity. Historically, when the ratio of value to growth stocks exceeds the upper limit of Vanguard’s estimated fair-value range, the chance for market-beating returns appears to be larger in growth stocks. When that ratio is below the lower limit, the opportunity appears to be larger in value stocks.

Historical Underperformance and Future Potential

After an overvaluation in 1993, value shares underperformed growth by a cumulative 8 percentage points over three years. However, the extreme undervaluation of value stocks during the 2000 tech bubble was followed by value outpacing growth by 59 percentage points in a year. A similar undervaluation in 2020 resulted in a 46 percentage point outperformance for value over about 20 months.

Currently, value is again notably underperforming in relative terms. The Russell 3000 Growth Index, for example, returned 32% year-to-date as of July 31—more than three times the 9% return of the Russell 3000 Value Index. DiCiurcio suggests that market performance across the dozen U.S. business cycles since 1980 provides a reason for optimism on value.

Takeaways

As we wait to see what Powell’s speech might bring, it’s clear that the market is in a state of flux. Investors should consider the potential of value stocks, which have historically shown strong performance during economic recoveries. With relative valuations and economic conditions as they are, an overweight to value stocks could help offset the low broad-market returns expected over the next decade.