Where should value investors be looking?

Value investors have dealt with underperformance for more than two years.

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But a reversion to the mean in the value investing cycle is due, says Foster Corwith, a portfolio manager with Causeway Capital Management in Los Angeles. He manages the Renaissance Global Markets Fund.

“If you look at historical periods, drawdown is nearing trough levels.” That’s based on his analysis of foreign-exchange volatility, current interest rates and structural changes in businesses like retail. “Good historical periods [that] are analogous would be the late 1990s and 2007-2011.”

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But the coming shift in the value investing cycle will be unpredictable. This year has been a good example of why, given what we’ve seen during the first five months of 2016, he adds. “If you think back to January and February, you saw value as a style collapse, and then you saw a strong rally in value through the second half of March into April. Now, you’ve seen that tail off again.”

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As a result, says Corwith, investors focusing on value haven’t seen either strong or weak performance overall. Instead, there have been pockets of opportunity due to market volatility.

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These days, such investors are looking toward resource, mining and energy businesses in the wake of weak oil prices, he notes. But financials are a bright spot that’s being overlooked.

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Corwith explains, “Financials make up one of the largest components of the value index.” So for these companies to be ignored is relatively unusual historically, especially since inflation is up—it has risen steadily in Canada since January. “It’s unusual for the market to be telling you that inflation is coming in some industries but not in others. Banks are primary beneficiaries of an inflationary environment but [markets aren’t] willing to assign value” in the financial sector.

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He suggests investors monitor both energy and financials. “If you think about current gold and oil prices, they’re really selling the inflation [outlook].”

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