The Iran war has created a reshuffle in investing. High-flying tech companies are out while unloved old economy names are getting a second look.
Value stocks have been on a tear. In the March quarter, the Bloomberg 500 Value Index, which tracks companies that appear inexpensive based on metrics such as earnings yield, posted the second-strongest quarterly outperformance over its growth counterparts in more than 30 years. It was an encouraging development for a style of investing that has done poorly since 2019.
But as markets warm up to the idea of more peace talks and a ceasefire, the tech-heavy growth stocks are once again attracting inflows. So the question now is whether the rotation seen in the first quarter will take hold, or whether value stocks may just be behaving like emerging markets, which are in danger of being little more than a one-trick pony.
First, it's worth asking what prompted the rally in the first place. Much of it is sector rotation. The value bloc is peppered with banks, energy and industrial companies, while growth is dominated by tech.
Even before the conflict with Iran began on Feb. 28, value stocks were getting a lift from the so-called AI scare trade, which predicts that the arrival of new, AI-powered players will reshape competitive landscapes in the software industry. As investors questioned the sustainability of recurring sales at legacy tech firms such as International Business Machines Corp., they sought comfort from the industrial complex, which requires higher upfront capital expenditure and is therefore harder to enter and disrupt.
The Iran conflict only turbocharged the rally. Higher oil prices benefited energy stocks such as Exxon Mobil Corp. and Chevron Corp., which sit in the value category.
In addition, President Donald Trump is rewriting the rules for America's biggest banks. The latest proposals could reduce the amount of capital banks have to put aside to absorb losses by 4.8%, freeing up billions of dollars for corporate lending, dividends and share buybacks. It's a boon for the likes of Goldman Sachs Group, Morgan Stanley and JPMorgan Chase & Co.
According to Nick Giorgi, chief equity strategist at research group Alpine Macro, the value bloc tends to win during three environments, namely, commodity surges, tech bubble blowups and early credit booms. The catalysts that underpinned value's recent winning streak can fit loosely into each category.
But it's questionable whether these catalysts have enduring power. First, do investors really see a lasting energy supercycle? Granted, even after a peace deal, oil and gas prices could be higher than before the bombing began, as the Middle East oil-producing nations need time to repair damage to their energy infrastructure. But with much of the world going clean and China becoming an electrostate, demand for traditional energy resources is capped.
Meanwhile, this week's earnings show that banks were already priced to perfection. A blemish in an otherwise stellar report card prompted a slump in Goldman Sachs' stocks. As for the AI scare trade, the narrative has practically disappeared as the tech-heavy Nasdaq 100 Index notches a 10th straight day of gains, its longest such streak since 2021.
After all, the burden of proof is on value. Since 1981, this style has outperformed growth only 30% of the time using a three-year holding period, according to Alpine Macro. Durable outperformance has become difficult as episodes of commodity boom, credit thaw and tech selloffs get rarer.
Over the years, value investing -- a strategy that once worked for Warren Buffett -- has been dogged by questions of whether it still makes sense. A few months of outperformance alone doesn't justify a lasting place in portfolio management. Value investing is not out of the woods yet.