Value stocks have underperformed most other styles of investing, as well as the broad market, by a wide margin since the beginning of 2015. We see several reasons why, which point to the catalysts for a potential recovery; we do not think Value is past its prime.
Historically, stocks with certain characteristics (known as factors), such as Value, Profitable Growth, Income, and Quality, have beaten the broad market over long periods. But stocks with each of these characteristics have followed a distinct performance pattern, doing better or worse at different times.
In recent years, Value stocks—representing companies that are (arguably) inexpensive due to a short-term controversy—have been cast aside in favor of faster growers. Does this mean that Value investing is past its prime? We don’t think so. We see rational drivers for its underperformance, and a number of catalysts for a comeback.
Since the beginning of 2015, Value has lagged the broader market (Display), while Income, Quality, and particularly Growth stocks have taken the lead. Will the trend continue …or is Value poised for a rebound? Before we can answer, we need to understand the reasons for Value’s recent lackluster results.
The macroeconomic environment shoulders some of the blame. The recovery from the global financial crisis of 2008 (“GFC”) has been marked by low growth and subdued inflation—conditions that favor faster growers. Why? When growth is hard to come by, investors place a premium on companies that can grow through any environment. Facebook, Amazon, and Alphabet (i.e., Google) are current examples.
WHAT DO YOU EXPECT?
The mechanics of Value create headwinds in this environment, too. Value investing seeks to exploit investors’ overreaction to short-term events in the hopes that a company’s stock will revert to fair value once management finds a fix or industry conditions improve. This so-called reversion to the mean has been called into question by slow economic growth and benign inflation. That’s because companies’ future steady state returns may be lower than the historical averages and, for many investors, less rewarding. This has made Value stocks appear less attractive—especially considering the risk that some companies may not get there at all.
Structural shifts in several industries—such as retail, pharmaceuticals, and energy—makes it even more difficult to assess what steady-state returns should look like. Take retail, for example. Department store giants like Macy’s and JCPenney have been struggling, and some view their stocks as a tempting buy. The challenge is determining fair value for the department store of the future when we don’t yet know what the department store industry will look like.