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The gap between cheap and expensive stocks is the widest in 70 years

Key Points
  • The valuations spread between cheap stocks and expensive stocks is at its widest in 70 years, according to AB Bernstein.
  • Value, as an investing style, tends to outperform when dispersion is wide and there have been downward earnings revisions, says Bernstein's Inigo Fraser-Jenkins.
  • Bernstein said investors could buy cheap individual stocks in different sectors, or they could buy stocks that are "cheap per unit fundamentals," their so-called "residual value factor."
Traders and financial professionals work ahead of the closing bell on the floor of the New York Stock Exchange.
Johannes Eisele | AFP | Getty Images

For investors struggling to find opportunities after a stellar rebound in the aging bull market, value stocks might be the best bet.

Case in point: Cheaply priced stocks are getting cheaper as expensive stocks have gotten extremely pricey, pushing the valuation gap to the widest in 70 years, according to AB Bernstein. The record dispersion puts cheap equities in a sweet spot as other pockets of the market start losing the appeal because of their high prices.

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"Value tends to outperform when dispersion in valuations across the market is at its widest," said Bernstein's Inigo Fraser-Jenkins in a note on Wednesday. "Valuation spreads are incredibly wide and sentiment may have found a floor. This provides a support for value within the market contrasted with traditional asset classes which are mostly fully valued."

The stock market has staged a strong comeback, with the notching the best two-month start to a year since 1991, but value stocks seemed to have missed the rally. According to Bernstein, the composite value stocks lost 1.04 percent year-to-date, versus the S&P 500's more than 11 percent gain. Many have argued that the market rebound is not fundamentally driven, as earnings and growth expectations have come down.

"Value as a style tends to perform better than average when there have been extreme troughs in the earnings revisions balance series particularly 6 to 12 months following the point of most aggressive downgrades," Fraser-Jenkins said.

Wall Street analysts have been aggressive when it comes to slashing their earnings expectations. The estimates for the S&P 500's first quarter earnings have dropped 6.5 percent in the first two months of 2019 alone, the largest cut since the first quarter in 2016, according to FactSet. Analysts are projecting an earnings loss of 3.2 percent in the first quarter and a gain of 4.1 percent for 2019.

Bernstein said investors could buy cheap individual stocks in different sectors, or they could buy stocks that are "cheap per unit fundamentals," their so-called "residual value factor."

The stocks that screen well on residual value and are also rated outperform by Bernstein analysts include Imperial Brands, DowDuPont, Goldman Sachs and Micron Technology.

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