Perhaps it is not a coincidence that as concerns linger regarding valuations on U.S. stocks the value factor is making a comeback this year. That, after value lagged growth for the better part of a decade.
Rising multiples on the S&P 500 leave investors wondering how much more can be juiced of what is already one of the longest bull markets in U.S. history, another scenario that underscores renewed affinity for value and the corresponding exchange-traded funds.
So, it might be a good idea to do what many have already done and evaluate value ETFs. Here is one with hidden gem potential: the PowerShares Russell Top 200 Pure Value Portfolio (PowerShares Exchange-Traded Fund Trust (NYSE: PXLV)).
Now could be a particularly good time to consider an ETF like PXLV, as the Federal Reserve mulls higher interest rates once more.
“Historically, there has been an inverse relationship between the 10-year Treasury yield and the S&P 500’s P/E ratio. This relationship is not altogether surprising, since the value of a stock is based in part on the discounted value of earnings. As a result, interest (discount) rates tend to affect valuations.
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“Based on simple discounting math, an investor would pay more for $1 of earnings when interest rates are 2.5 percent than when interest rates are at 10 percent. The lower the rate, the higher the present value,” said PowerShares in a recent note.
PXLV tracks the Russell Top 200 Pure Value Index, which “is composed of securities with strong value characteristics selected from the Russell Top 200 Index,” according to PowerShares.
Where Value Comes In To Play
Like many value ETFs, PXLV is heavily allocated to the financial services and energy sectors. Those sectors combine for 54.5 percent of the ETF's. Not surprisingly, those are two of the sectors that currently trade at valuations considered attractive relative to the S&P 500.
“Lower yields have tended to lift P/E ratios, although the relationship has varied by decade. During the 1970s and 1980s, the relationship was clear. In fact, the 10-year Treasury yield explained 73 percent of the variation in P/E ratios during the 1970s, and explained 70 percent of the variation during the 1980s. By contrast, the 10-year Treasury yield explained only 16 percent of the variation in P/E ratios during the 1960s. More recently, quantitative easing has distorted the relationship,” noted PowerShares.
PXLV has outperformed the Russell 1000 Value Index by about 130 basis points over the past year.
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