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Is value set for a comeback?
Since 2008, value investing has underperformed growth investing for the longest period on record. As a result, at the end of August, value was trading at its widest valuation discount to growth since the Dotcom Bubble of the late 1990s.
And value’s performance since the financial crisis has been unexpected. Value investing as a style has historically outperformed growth more. Still; past results are no guarantee of future performance, and there’s no guarantee that value will recover.
However, as Franklin Templeton points out when major global central banks begin policy normalization, the idea of mean reversion, or normalization, offers an intuitive argument for an eventual recovery in value. Securities trading at a discount to the fundamental value of their underlying businesses are not likely to maintain that discount indefinitely.
For value investors looking to snap up bargains, there hasn’t been an opportunity like this since 2000. The price-to-tangible book value of the MSCI World Value Index vs. the MSCI World Growth Index is now at its lowest level since late 2000/ early 2001. Value-oriented stocks trade at a 75% discount to growth in terms of price-to-tangible book value — two standard deviations below the long-term average level based on figures to the end of August.
According to Franklin Templeton, it’s unlikely that value will continue to trade at a discount to growth indefinitely. The concept of mean revision offers an intuitive argument for an eventual recovery in value.
The post-global financial crisis era brought a new wrinkle to the idea of normalization: ZIRP—the zero-interest-rate policies pursued by the world’s most powerful central banks. Indeed, the rising tide of cheap, readily available credit has seemingly lifted all boats, delaying bankruptcies and restructurings and creating a broadly indiscriminate trading environment. Sustained high equity correlations still stand as a testament to the market’s indifference to bottom-up fundamentals.
Meanwhile, the almost non-existent yields offered by bonds perceived as “risk-free” has forced investors up the risk curve into higher yielding debt. Bond investors have also been forced into equities in their search for yield and equity investors chasing growth in a yield-starved environment have incurred a tremendous amount of volatility just to keep up.
“This is not how the market’s risk–reward proposition is typically framed over time. Dislocations have become extreme, and once conditions potentially normalize, the market’s eventual snap-back to its typical function as cash-flow discounter and value arbiter could be profound, much to the potential benefit of patient, value-oriented equity investors.” — Source
Tracking interest rates
Historically, the performance of value as a style has been closely correlated with the interest rate cycle. If you believe that interest rates will never head higher again, then value isn’t the strategy for you. But if we take the view that over the long-term, interest rates will head higher, value as a strategy is appealing for the long-term investor. The Fed’s long-term directional preference is clear when it comes to interest rates.
The entire discipline of value investing revolves around buying stocks when they are out of favor. Global stocks recently have been correcting, value has underperformed for the longest stretch on record, and we may be approaching the trough of a long-term interest rate cycle; what better time for contrarian investors to re-commit to value?
This story first appeared in ValueWalk.
Photo: Allan Ajifo