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Value stocks trade at a record discount, and it could mean a major summer rally

Value stocks are their cheapest ever, JPMorgan says

Value stocks have never been this cheap, and that could mean a major rally is coming for the group this summer, according to one top strategist.

"We're seeing a pretty massive gap that opened up between growth, low vol, high momentum stocks relative to value," Dubravko Lakos, head of U.S. equity strategy at J.P. Morgan, told CNBC's "Trading Nation" on Tuesday. "When you look at valuations, for us the basket is blown out to not just cycle highs, but record highs."

JPMorgan tracks value through a basket of 100 stocks picked for their low price-to-book value, price-to-earnings ratio, and price-to-sales ratio, among other indicators. According to Lakos, this collection of stocks is trading at their cheapest valuations ever and at their largest discount to the market in decades.

"Value is now trading at about seven times discount versus the market. Last time we saw it was basically year 2000 at the peak of the TMT growth bubble," he said. "You're seeing a lot of these correlations also between value stocks and the flipside, momentum, hitting extreme negatives. So, you have basically a situation that we think is ripe for potential rotation."

Lakos' value basket includes Citigroup, Ford, Walgreens, GE and General Motors. The broader IVE S&P 500 value ETF, which contains close to 400 low-valuation stocks, has outperformed this month with a 6% gain compared with the IVW growth ETF's 4% increase.

Before an even bigger rotation rally into value occurs, Lakos needs to see two things.

"One potential catalyst is … the Fed that basically embarks on some potential rate cuts which is part of our house view going into the second [half of the] year," said Lakos.

Any resolution in ongoing trade talks that have rattled markets this year would also give rise to the value trade, he added. In a separate phone call with CNBC's "Trading Nation," Lakos said those two catalysts could give his value basket an average 20% to 30% spike within three months.

A longer-term bet on value still faces significant headwinds, though, he says. Until these dissipate, he says, a play on value needs to be short term — over the next few months rather than years.

"Rates are very low and that's … basically ignited a lot of these different growth companies, growth projects that investors are chasing," said Lakos. "Value characteristics from a fundamental point of view are no worse than what they were in previous cycles — if anything, in some cases they've slightly improved — but it's the other side of the trade, the growth trade, that has possessed extremely strong quality properties for much longer than what we've seen historically."

Given that dynamic, investors are far less likely to give up the riskier, but high-reward, growth trade to rotate back in value stocks for the longer term.

Value stocks could see massive rotation rally this summer, JPMorgan says