Quantitative investing analysis reveals a bigger story of anomalous short-term performance patterns
The continuing underperformance of the value factor has many investors scratching their heads, particularly as the continued rollouts of vaccines against COVID-19 promise an economic rebound ahead. But that’s not the only one that’s performing worse than anticipated.
In a new blog post, Stephen Duench, vice president and portfolio manager at AGF Investments noted that while high-beta, high-leverage, and small-cap factors have led a charge in the equity markets that’s persisted since the start of 2021, value has been uncharacteristically silent.
“[S]everal metrics synonymous with value, including trailing and forward price/earnings multiples, are associated with some of the weakest returns over the past year, and that trend has only accelerated through January and February,” Duench said, citing an AGFiQ analysis of FactSet data on S&P 500 factor returns.
While price-to-book ratios have been associated with a roughly 8.5% return for the first two months of the year, other measures of value have shown factor returns ranging from zero to -10%. That recent run of underperformance represents one of the biggest anomalies in the current equity markets – though another factor is behaving in an unexpected manner.
“Our research shows that quality, a perennial underperformer during early stages of a new cycle, has not lagged this much in several years relative to other factors,” Duench said.
According to Duench, S&P 500 companies with strong returns on equity and high margins relative to their own sectors are doing worse now compared to the immediate aftermath of the Global Financial Crisis, and in the early wake of the early-2000s Tech Wreck. That dismal showing has been persistent this time around, he added, that the gains quality has posted in prior cycles have been all but erased.
“In other words, while value has fallen short of expectations by not outperforming at the start of this new cycle, quality is overshooting the mark by underperforming more than expected,” Duench said.
Looking at the overlap in rolling correlations of price-to-earnings multiples in relation to various quality factors, AGFiQ’s research determined that value and quality have rarely been so inexpensive at the same time.
“At least in the short term, both value and quality could continue down the extreme paths they have recently travelled and put further strain on portfolios that are not properly diversified or that are tilted too heavily towards these factors over others,” Duench said. “However, sooner or later, there is every reason to believe that the performance of both these factors will revert to their historical means and make up for lost ground.”
