While September seems to have brought calmer markets at the headline level, beneath the surface this has not been the case. The past few weeks have seen momentum and growth trades come under pressure, with value outperforming growth by 4.1% since August 27th.

From a macro standpoint, weakness in manufacturing beginning to infect service sectors and the consumer remains the biggest risk to the economy; while the lack of resolution on U.S./China trade has kept this risk alive and well, it did appear that interest rates had fallen too far too fast in recent months as government bond markets and other defensive assets priced in a rising risk of recession.

As interest rates have moved higher, value has outperformed. Energy and financials have led the charge, while the bond proxies – which largely sit in the value space but command smaller weights – have lagged. The question for investors is how sustainable this rally may be. In general, value tends to outperform growth in periods of rising interest rates and improving manufacturing activity. While we see room for rates to grind higher as fears of imminent recession fade into the background, it is unclear whether the clouds over manufacturing will break in the coming months. There have been reports that the U.S. and China are making progress with respect to trade, but one has to wonder whether businesses will react. The rule book that has governed trade and supported globalization for the past 25 years seems to have been thrown out the window, suggesting that at a minimum, uncertainty looks set to persist. This will likely prevent any significant, near-term improvement in manufacturing.

Despite this cloudy short-term outlook, cyclical value continues to provide us with long-run opportunities. Valuations are compelling compared to both growth sectors and the S&P 500, with value nearly 1 standard deviation cheap relative to both growth and the broad market. Furthermore, given our expectation for continued uncertainty, focusing on those sectors that provide a healthy stream of income seems prudent. Finally, given how unloved these sectors have been over the course of this bull-run, the downside seems a bit more limited relative to some of the high-flying sectors that have captured investor hearts and minds. As such, while this short-term rally may fizzle out, there are long-run tailwinds supporting value as a style.

Year-to-date value and growth relative performance

S&P 500 Value index/S&P 500 Growth index

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Source: Standard & Poor's, FactSet, J.P. Morgan Asset Management.