Value Investing Under The Microscope

No matter how many different ways one slices and dices the value investing universe, it’s getting little respect.

“One thing remains true: Cheap stocks have had an unhappy decade,” declares GMO’s John Pease, a member of the firm’s asset allocation team. From 1981 to 2006, value stocks outperformed by 2.3% annually, even factoring in the tech boom of the late 1990s. Since then, however, they have outperformed in only four of the past 13 years.

Long-suffering value investors received a brief reprieve in early September as swarms of investors ditched pricey quality and momentum stocks and bought shares of cheaper companies in a big way. But even if investors who believe growth investing will dominate the investing landscape forever got a wake-up call, many value acolytes still need convincing.

In a letter to clients early in the summer, Oaktree Capital co-founder Howard Marks observed that value investing was suddenly being portrayed as a cousin of “cigar-butt” investing, when people ignore asset quality and only focus on price and quantity. As the world’s largest distressed debt investor, Marks is famous for noting that cheap asset prices and intrinsic value are two very different things.

Many believe what happened in late summer was little more than a head fake similar to the market shift that occurred in 2018’s fourth quarter and during the months following President Trump’s election. Top-performing managers, most of them with growth stock-heavy portfolios, suddenly realized companies trading at 30 or even 40 times earnings were highly vulnerable to an economic slowdown and a change in market sentiment.

In the first two weeks of September, value beat momentum by 9%. “It’s logical the market’s preference changed,” says Mark Finn, manager of the T. Rowe Price Value Fund. But he isn’t convinced “we’re witnessing the infancy of a long value renaissance.” Instead, he believes it’s “just a period where growth became too expensive and value became too cheap.”

For much of the last year, portfolios positioned in defensive stocks and high-growth businesses have been right. After several years when consumer staples stocks struggled with weak unit sales growth and a strong dollar, many concerns like Procter & Gamble and Coca-Cola have managed to re-energize their revenues over the last year. These so-called quality companies also boast predictable earnings and strong balance sheets, and dividend yields that beat 10-year Treasurys.

Value stocks need a reacceleration of global growth to regain market leadership, according to Jurrien Timmer, head of global macro at Fidelity Investments. GDP growth has been anemic during the current cycle. While the U.S. has expanded faster than other developed nations, it hasn’t recorded a single year of 3% GDP growth.

This is why investors have rewarded less cyclical, asset-light, winner-take-all companies with lots of free cash flow, Timmer says. The majority of these businesses reside in America. “It’s why the U.S. has outperformed, large-cap has outperformed and growth has outperformed,” he explains.