The duration and magnitude of value’s recent underperformance has caused many to ask once again if value investing is no longer effective. While it is possible that secular shifts have helped to compress value’s premium relative to its long-term history, we believe most of the recent decline can be traced to more transitory factors. Our research indicates that value’s underperformance has stemmed from multiple factors including, among other things: a smaller relative income benefit; less tailwind from rebalancing; and an increasing discount to the market. We also believe that even if the normal value premium has compressed, value is currently priced to outperform across all regions.
2018 marked another year in which U.S. value stocks underperformed relative to the market (and, of course, growth stocks). Value stocks have trailed the market in 9 of the last 12 years by an average of 2.0%1 per year. This value deficit during this most recent cycle stands in contrast to the long-run premium generated by buying cheap stocks.2 Decomposing returns suggests the value premium stems from multiple drivers of relative performance and recent underperformance comes from a variety of those sources, not one sole culprit. We believe many of these effects have been time-specific and will revert to value’s favor, making this a particularly attractive time to lean into the value style. To be fair, our research suggests some historical value drivers may in fact provide less benefit going forward. This combination leaves us confident that value stands well-positioned over the mid term, but may not be able to match its historical levels of outperformance over the longer run.
This note, in which we analyze the drivers of value’s historical outperformance, is intended to serve as an appetizer to a more comprehensive research paper my colleague John Pease will be publishing soon. John’s work suggests that value’s recent underperformance is not due to an erosion in the fundamental growth of value stocks. Value fundamentals – the group’s historic level of under-growth – have been consistent with history. Instead, value stocks have accrued less benefit from higher relative income and the rebalancing effect. Moreover, value has experienced a negative valuation impact because cheap stocks have not seen their multiples expand as much as the broad market during this recent cycle. As a result, we believe value stocks are priced to outperform across all regions.