The following chart shows a similar inverse relationship between growth in the inventory-to-sales ratio and economic output, as defined by industrial production. Here, I’ve also inverted the inventory-to-sales curve to highlight the relationship between the two metrics.
Value or momentum? Why not both?
Despite recent signs of trade tensions with China and uncertainty over NAFTA negotiations, a potential elongation in the economic cycle could provide reason for economic growth. And a strategy that combines both momentum and value may provide a compelling means of positioning portfolios for these conditions.
Consider, for example, the S&P 500 High Momentum Value Index, which picks the 100 stocks within the S&P 500 Index with the strongest recent value and price momentum scores. The momentum overlay seeks to avoid value traps by gaining exposure to value stocks that are displaying relative price strength. (A value trap is a stock that appears to be cheap by traditional valuation metrics, such as price-to-book. The trap springs when investors buy into the company at low prices and the stock never improves.)
The fund that tracks this index — the PowerShares S&P Value With Momentum Portfolio (SPVM) has a price-to-earnings ratio of 13.78, which is 25% lower than the S&P 500 Index.1 Moreover, SPVM’s low price/earnings to growth (PEG) ratio indicates that its valuation is more attractive than the S&P 500 Index. As of Jan. 26, the PEG ratio for SPVM was 1.32, compared with 1.77 for the S&P 500 Index.1
For the moment at least, valuations and inventory levels appear to be on the side of value and momentum investors.
This article has been republished with permission from Invesco Powershares.