By Jacob Sonenshine

That was a nasty selloff. Now it's time to go shopping.

It's been an ugly week for the stock market. The broad-based S&P 500 index dropped 2.3%, while the growthier Nasdaq Composite fell 2.1%. But it was particularly bad for the Dow Jones Industrial Average. This past week, it suffered its eighth straight day of declines on Monday, even as the Nasdaq was hitting a record high -- the first time that's ever occurred. Its losing streak extended to 10 days, its longest since 1974, before ending with a 15.37-point rise on Thursday. All told, the Dow has lost 2.6% for the week.

Despite recent additions, including Nvidia and Microsoft, the Dow has a value tilt, favoring stocks with low valuations relative to the market. And value stocks have been having a tough time. The Invesco S&P 500 Pure Value exchange-traded fund (ticker: RPV), which counts General Motors and Citigroup among its top 10 holdings, has dropped 4% this week and 7.8% this month, far worse than the S&P 500's 2.4% December decline.

There's a reason for that. Value stocks tend to be more sensitive to the economy, so anything that shakes confidence in future earnings is more likely to be reflected in their stocks than in their growth counterparts. The market was already assuming that the Federal Reserve would be less dovish in 2025, and the central bank leaned even more hawkish than had been anticipated when it signaled that it would cut interest rates only twice next year at Wednesday's meeting of the Federal Open Market Committee. Fewer rate cuts could mean slower economic growth -- and weaker returns for value stocks. A possible government shutdown isn't helping.

The potential bad news, however, looks thoroughly reflected in value stocks. The Pure Value ETF trades at just 10.1 times 12-month forward earnings, well below the S&P 500's 21.6 times and the Invesco S&P 500 Pure Growth ETF's $(RPG.AU)$ 23.8 times.

Now it may be time to play catch-up. A broad group of value stocks tracked by SentimenTrader senior analyst Jason Goepfert is near its lowest level versus growth in over two decades. The last time relative prices were at these levels in the early 2000s, value stocks went on to outperform growth over the coming years.

"There is more evidence that a skew toward value and away from growth makes sense now, more than before," Goepfert writes.

That's especially true when considering the fact that the economy is still growing in the low single digits and the Fed still hopes to cut rates a bit more next year. With some inflation, but not too much, companies can generate mid-single-digit sales growth next year. And if costs don't rise too quickly, margins should increase. That should help the Pure Value ETF grow earnings at a 17% clip next year. The result is that value's profits could catch up to growth: The Pure Growth ETF should grow earnings by 17% in 2025, down from 22% this year.

Add it all up -- the earnings, the valuation, the long-term underperformance -- and it seems like a good time to allocate a bit more money to value stocks now. "U.S. large value equities are very attractive today -- in fact, they have almost never been cheaper relative to the overall market," writes Ben Inker, co-head of asset allocation at GMO. "We believe large value stocks are positioned to outperform."

If not now, when?

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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December 20, 2024 11:58 ET (16:58 GMT)

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