Is Value Dead?

Given recent performance, some clients have raised the question about whether the value premium is “dead.”  As evidenced-based investors, we typically turn to the data to demonstrate and reinforce that value is one of the single most important factors in investing.  In fact, next to the equity premium itself (the stock market minus one-month Treasury bills), the value premium is, perhaps, the most persistent and significant.  From an economic perspective, if you believe and expect that there are differences in expected returns across stocks, one can easily extrapolate that there is a value premium.  This means that stocks with high discount rates are expressed as lower prices, which in turn, means that lower priced stocks tilt toward higher expected returns.  However, the value premia are highly volatile and can appear quite suddenly.  This means if you are not invested in these stocks, you will miss that momentum change and the corresponding upward movement of these stocks. 

You certainly would not have been faulted for dialing back on value over the past decade as it has been in somewhat of a bear market, especially when compared to growth stocks.  In the chart below, you can see how value has performed over a very long time horizon.  No asset class performs in a linear fashion as is evident in the graph.  However, a preponderance of years dating back to 1937 in the US, show the value premium has been accretive to those that had this exposure in their portfolios.

According to a recent communication from Bank of America, there are “several reasons” why investors believe there will be a comeback in value, including:

  • In 14 of the last 14 recessions, value stocks led in the recovery, and economists believe that we are nearing the GDP growth trough
  • Profits drive style cycles, and profits forecast indicates trough growth in Q2 2020. In every profits recovery except two (post-Tech Bubble and 2016), the trough to peak in corporate profits growth saw value lead by a large margin
  • Value is currently deeply neglected
  • Value stocks trade at record levels of cheapness relative to momentum stocks; furthermore, growth factors trade at a record premium to the market on almost any measure

Finally, the top stocks in the market, FAAMA (Facebook, Amazon, Apple, Microsoft and Alphabet) account for roughly 40% and 20% of the NASDAQ and S&P 500 respectively.  These are unsustainable valuations and will likely lead to lower expected returns of these growth stocks over time.  Therefore, value may well be about to see the light of day…again.

Is There Still Value in Pursuing Value?

The year 2017 tested the patience of US value investors. While US value stocks returned a decent 13.66% (as measured by the Russell 1000 Value index), they were overshadowed by the phenomenal 30.21% return of US growth stocks (as measured by the Russell 1000 Growth index) – an underperformance of 16.55%. This negative value premium marked the fifth worst year since 1979 and pulled the five-year rolling premium into negative territory. Ouch.

The pain for US value investors has persisted into 2018, with US value stocks underperforming US growth stocks by 6.01% 1. Despite this seemingly relentless underperformance, we believe there is still value in pursuing value for the long-term investor. Here’s why:

We have seen this movie before. Even over extended periods, underperformance of the value premium (or any other return premium) is not unusual. For example, over the 10-year period ending in March 2000, US value stocks underperformed US growth stocks by 5.61% per year (on an annualized basis). But this underperformance quickly reversed course. By the end of February 2001, US value stocks had outperformed US growth stocks over the previous one-, three-, five-, 10-, and 20-year periods.2
Return premia are nearly impossible to predict and relative performance can change rapidly. This underscores the need for discipline in an investment strategy.

Value rewards long-term investors. Empirical evidence dating back to 1926 shows that US value stocks typically beat US growth stocks, with the odds of outperformance increasing as the time period lengthens, as illustrated in the chart below3. For example, US value stocks beat US growth stocks in 61% of the 1-year rolling periods since 1926, while over the 15-year rolling periods the odds of outperformance increased to 94%. Similar track records have been exhibited in other markets, with value beating growth in developed ex-US markets in 95% of 10-year rolling periods since 19754. In emerging markets, value beat growth in 86% of 10-year rolling periods since 19895.

 

Beware the allure of growth trends. We’ll admit it: value investing can seem boring compared to its trendier growth counterpart. Take the popularity of FAANG (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) stocks. FAANG investors were undoubtedly well-rewarded last year, receiving a simple average of 49% (versus the S&P 500 at 22%); but merely latching on to the latest investment catchphrase does not an investment strategy make. Sure, the FAANGs do have their merits, but investors should not allow their allure to result in an overly tech-concentrated portfolio (remember the dot-com bubble?). Broad diversification across sectors and markets is a much more prudent investment strategy.

Bottom Line: Discipline and diversification are the name of the game. While there is empirical evidence to support our expectation that value stocks will outperform growth stocks over longer periods, there will be periods of underperformance. Discipline and diversification across multiple sources of return premia will lead to a more positive investment experience.

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1 Year-to-date total return of Russell 1000 Value index and Russell 1000 Growth index as of market close, 9 March, 2018.
2 Source: Dimensional Fund Advisors LP; total returns quoted are for the Russell 1000 Value and Russell 1000 Growth indexes.
3 Source: Dimensional Fund Advisors LP; Value is Fama/French US Value Research index. Growth is Fama/French US Growth Research index. There are 919 overlapping 15-year periods, 979 overlapping 10-year periods, 1,039 overlapping 5-year periods, and 1,087 overlapping 1-year periods.
4 Source: Dimensional Fund Advisors LP for the period ending December 31, 2017.
5 Ibid.

What is Smart Beta Investing?

 

Smart beta is a relatively new term in investment management, but the concept has been around for decades.  It is a type of factor investing which uses different rules of portfolio construction than traditional asset class investment.  The idea of smart beta is to add value to a portfolio by systematically selecting alternative weightings and portfolio holdings in a way that deviates from the manner in which traditional market capitalization based indices have been created. Regular re balancing is also part of this strategy.  

Drown Out The Noise – You Are Smarter Than You Think

I spent a couple days earlier this week at an investment conference. Whilst there, I was reminded of the volumes of empirical evidence supporting our investment philosophy. It was reassuring and affirming.  Even though I’m “in the business,” I’m not immune to the noise that is everywhere.  Talking heads on TV telling us which stocks are winners; newspapers telling us the sky is falling; co-workers telling us how great their investments are the greatest thing since sliced bread. These distractions are ever-present, and it takes true resolve to not be swayed by these externalities. Clients will often ask what we think of a particular event (How will Brexit impact me?) or security (Should I buy some Apple?) or perceived future risk (But what if Trump is elected?).  These questions are relevant and valid, but they shouldn’t cause you to deviate from your long-term strategy.

Investing: It’s An On-Going Process, Not A Point In Time

At any gathering around the world, I’m invariably approached by someone who wants to know when and where they should enter the market. For the past couple of years, those of my friends and family in the States have been pleased with how their portfolios have been performing.  I generally agree with them knowing that there is significant home country bias in their portfolios.  However, the rest of the world hasn’t fared as well.  In our market, primarily the US expat market, we hear something opposite from those in the States.  Presently, 22 August 2016, the US is all but fully valued (some may say over-valued) according to Research Affiliates . It’s impossible to pick and choose markets in advance to garner the benefits that appear to be easy to select in the rear view mirror.  Times are challenging now.  In fact, times are generally challenging.  Below are some of some of the key indices around the world to provide some insight as to how things really are and have been over the past few years.  It’s very easy to take a snippet from an article or listen to the talking heads on television and believe that markets are doing something they’re actually not.  As Wealth Managers, our job is to provide a solid portfolio structure that will give the best chance of a positive result based on risk appetite.  We diversify broadly, both from a geographical and industry perspective.  The easiest way to keep this in mind is to think about the late 1990’s.  Tech was the rage and if you weren’t in it, you would receive paltry high single to low double digit returns.  That was great while it lasted, but, like all other fads, that fizzled and many people and institutions were burned.  Don’t give in to the hype of greener pastures.  You’ve heard it before, this time, make sure you don’t go searching.

Should I Stay or Should I Go?

The title is from the British punk rock group, The Clash. However, it feels very relevant in today’s stock market environment. We have investors constantly enquiring as to when and if they should sell out of the market. It’s easy to understand this question, especially as this year is off to a horrible start. But, before doing anything, first try to understand what’s happening in the world. First and foremost, the global economy is still growing, even if its rate of growth is less than the “experts” believe. Take for instance the US, Banks and individuals are supposedly carrying a lot less debt now than they were. Therefore, if that’s the case, they should have more “rainy day” funds on hand if the downturn worsens.