UK and Japan are the best options in this category, which never does well during bubbles
The US Stock Market has entered bubble territory. Bonds from the developed world have negative real returns. To make matters worse, the 40-year fixed income bull market appears to be coming to an end. Long-term rate hikes pose a serious threat to investors. Your best protection may come, not from Alphabet or Amazon, who had a great 2020, but from their antithesis. The investment in value is ready to return.
This approach has a distinguished pedigree dating back to Warren Buffett’s mentor Benjamin Graham in the 1930s. There was a time when stocks that were cheap relative to earnings, book value, or sales were more or less guaranteed of superior returns. Between 1926 and 2009, US value stocks outperformed more expensive growth stocks by more than 4% per year. Composed over more than three-quarters of a century, it delivers far superior performance.
But the mortgage crisis subprime was especially cruel to these values, which at that time were concentrated in vulnerable sectors, such as banks and real estate. In recent years, value they have been crushed again. In a new article for the Financial Analysts Journal, Robert Arnott and colleagues note that they underperformed 55% growth (growth) between 2007 and mid-2020. It is the biggest and longest drop suffered by this strategy since there are records.
Different reasons, some better than others, have been adduced to explain this. There is a widespread belief that stocks that trade with lower earnings multiples perform worse when rates fall. In jargon, they are said to have less “duration” than growths. But Arnott believes that the recent poor performance of value it is not correlated with the drop in interest rates. Additionally, Ben Inker, head of asset allocation at GMO, a Boston money manager (and former boss of me), argues that, adjusted for portfolio turnover, both strategies have similar durations.
In the past, the superior performance of values was largely due to their profitability improving over time. It has been argued that the advancement of the internet and the recent plague of corporate “zombies” have interrupted the reversion process to the mean that has historically benefited them. But there is little evidence for that. The value it continued to do well in Japan in the 1990s, as zombies proliferated and rates fell to zero.
The values have performed poorly because investors chose to pay a higher premium for the growth and, in particular, by a handful of big tech companies. They have also been hurt by passive investing. Huge inflows into capitalization-weighted index funds benefited the FAANGs (Facebook, Amazon, Apple, Netflix, and Alphabet), as they absorbed investment capital from value strategies. Retailers operating on Robinhood and other commission-free platforms have added to the noise, driving Tesla, Palantir and several SPACs up. The value never goes well during bubbles.
To make matters worse, declining stocks, which tend to be from more cyclical sectors, have suffered greatly in the pandemic. Big technology, on the other hand, has prospered. In August, the values growth traded at an unprecedented accounting multiple of 13 times that of the value. Part was deserved. The growth They have recently demonstrated their ability to keep up with earnings growth longer than in the past. But markets tend to take things too far.
Arnott’s colleagues at Research Affiliates, a Californian investment advisory, believe that the value It has shown better performance when the bubbles burst. The last time US stocks were this expensive was at the height of the dot-com bubble. After it deflated, it blazed a trail of superior performance that lasted for several years. Value also performs well in the early stages of recovery.
Market confidence is once again leaning towards this old-fashioned style. The low performance of value It ended at the end of the year, when investors began to contemplate the end of the pandemic. In November, the Morningstar Index of US small-cap stocks rose more than 20% and gained another 11% in February. The international value has also rebounded. Still, Arnott argues that the sector remains relatively cheap, and has the potential to continue to outperform the market as the world economy recovers.
There is a but. The actions value The US may be less overrated than Tesla and Netflix, but they are not especially cheap relative to their own history. That means that when S&P 500 sales begin, these stocks are likely to lose money on average, even doing better than the general market.
The good news is that there are better opportunities elsewhere. In the UK, values were crushed first by Brexit fears and then hit by lockdowns. The prospects are more promising. Britain has already vaccinated a large part of the population and its exit from the EU, although uneven, has not been as disastrous as the doomsayers envisioned. Research Affiliates believes that UK value offers the ‘deal of the decade’.
The actions value of the emerging economies have the same expected profitability as the British, but with more volatility. Both Arnott and Inker agree that the value Small-cap Japanese is especially attractive. An international diversified basket can be expected to offer a real annual return of 5% -6% in the coming years. This is a fair bargain, if not a great one, in absolute terms, and perhaps the best option for investors to preserve capital when the next market crash arrives, as it inevitably will.