Value hunters must cool their triggers

The bombing of Saudi Aramco’s oil processing facilities has triggered a topsy-turvy period for oil markets. Crude prices have soared, lifting the shares of neglected energy producers. Energy stocks, along with financials, usually fall into the category of inexpensive equities labelled “value”. These have long trailed the broader market.

Value fund managers, the perennial underdogs of the investment world, have grounds to believe they are now alpha animals. They should think again.

Value encompasses those shares trading at low valuation multiples versus their respective earnings, or book values, and those offering high dividend yields. Many oil and gas companies, such as Chevron and Total of France, fit this screening. So do banks.

Financials are by far the largest sector in MSCI’s value index, with nearly a quarter of the weighting. Both financials and energy tend to suffer from relatively low priceto-book ratios. European banks on this ratio trade near decade lows. This means the market has a lower opinion of these assets than the companies do themselves. Technology groups have less shareholder equity, but deliver higher returns on it.

Integrated oil firms with increasing amounts of free cash flow will receive more attention from now on even if crude prices only move sideways. Large European oil producers offer dividend yields of around 6%. But without a much steeper bond yield curve, to lift loan profitability, expecting a lot more from banks seems a stretch.

Any hiccup in the bond market, pushing up yields, tends to attract value hunters. Unfortunately, a sharpish sell-off in longer-dated US Treasury notes in September has now fizzled out. Moreover, the value factor usually springs to life at the early stages of recovery, not late in an economic cycle. Value will have its day, just not today. /London, September 18

© The Financial Times 2019