In the previous two columns, I showed why value’s losing streak to growth since around 2007 is among the worst, if not the worst, in nearly 100 years, and why popular explanations for value’s latest slump don’t quite add up. Now let me offer an alternative explanation, one that is far simpler: Like any investing strategy, value disappoints occasionally and sometimes for long periods, but it will be back.
Investors readily and rightly accept that explanation in many other contexts, not least when it comes to the contest between stocks and bonds. They expect a higher return from stocks than bonds, even though they realize stocks won’t always win. That expectation is grounded in experience, intuition and, most important, data. Since 1926, the S&P 500 Index has beaten long-term government bonds by 4.4 percentage points a year, including dividends, and 83% of the time over rolling 10-year periods, counted monthly.
That makes good sense. Stocks are riskier than bonds. They’re more volatile and more susceptible to gut-wrenching declines. If they didn’t also promise a greater reward, no one would buy them. That risk-return tradeoff isn’t negated by the fact that stocks lose to bonds occasionally. If anything, it’s part of the risk that stock investors are paid to bear. The same is true of the risk-return tradeoff between value and growth. If wobbly value companies didn’t promise to pay more than stout growth ones, who would bother with them?
And that’s not the only similarity. Like value, stocks haven’t paid in a long time. During the 20 years that ended in September, bonds beat stocks by 1.6 percentage points a year. Think of all the trouble investors could have sidestepped during the last two decades, not to mention the additional money they could have made, if they had swapped stocks for bonds. And yet there’s little grumbling about stocks.
So why all the hand-wringing about value? One reason is that stocks haven’t burned investors as badly. While bonds have beaten stocks by close to 2 percentage points a year since 2000, growth has beaten value by closer to 8 percentage points a year since 2007. Also, this isn’t the first time investors have seen stocks stumble and regain their edge. The famously misguided BusinessWeek cover in 1979 declaring “The Death of Equities,” after a miserable decade for stocks and just before the start of a two-decade bull market, is burned in many investors’ brain. And if that didn’t stick, then stocks’ slump and subsequent recovery in 2000 and 2008 reinforced the message: When it comes to markets, it’s not safe to extrapolate from recent experience.
By contrast, many investors haven’t seen enough of value’s cycles to have the same confidence that its current slump is temporary. This is where a longer view of history is helpful. Yes, value has disappointed before — and the periods that followed were hugely lucrative for value investors. Growth’s valuations have ballooned relative to value at least three times, just before and during the Great Depression in the late 1920s and mid-1930s, the Nifty Fifty craze of the late 1960s and early 1970s and the dot-com mania of the late 1990s. In all three cases, value easily outpaced growth in the years that followed, in one case by upwards of 10 percentage points a year during the 1970s and early 1980s.
Where are valuations now? The gap between growth and value is as wide as ever. Growth is as expensive relative to value as it was at the peak of the dot-com bubble in 2000, based on price-to-book ratio in September, which is the widest gap by far in the nearly 100-year record. And the valuation gap is just a hair narrower than it was in 2000 based on price-to-earnings and price-to-cash flow ratios.
There are many ways value can close that gap. Value companies, for instance, may prove to have more fight than investors assume. Walmart Inc. could disrupt Amazon.com Inc.’s quest for retail dominance, Walt Disney Co. could gather more eyeballs than Netflix Inc., or Ford Motor Co. could work out how to produce and distribute electric cars more cheaply than Tesla Inc. Or perhaps growth stocks won’t shine as brightly going forward. Behemoths such as Apple Inc., Amazon, Facebook Inc. and Google parent Alphabet Inc. may struggle to maintain their eye-popping growth, or the government may decide to break them up. Any of those things are likely to cause investors to rethink valuations.
As it happens, value is showing hints of a renaissance. Russell 1000 value companies have outpaced growth by 4.6 percentage points since Nov. 3 through Tuesday. It’s too early, of course, to trumpet value’s return, but don’t be surprised if fortune is beginning to favor value again.
Sound far-fetched? Billionaire investor Howard Marks likes to say that markets hate certainty. There may be nothing more certain in investors’ minds right now than the proposition that value stocks are a lost cause. When value reemerges — a question of when, not if — and headlines shriek with amazement, don’t call it a comeback.