Its inverse correlation with another highly-sought factor shows no signs of unravelling any time soon
In recent weeks, the long-dormant value trade showed signs of reanimation; momentum trading hit a wall as investors rotated, some might say violently, into companies with lower valuations. But as tempting as it is to believe in a much-anticipated comeback, investors might want to reserve judgment for now.
“In recent weeks, developed-market companies with shares that trade cheaply relative to their forecast earnings have suddenly started doing well,” reported The Wall Street Journal. It referred to the MSCI World Value Index, whose returns of almost 4% on the month has outpaced those for the broader index (2%) as well as growth stocks (1%).
The move in value has turned heads, understandably so. Value shares have massively underperformed since the 2008 financial crisis; any return to the market conditions of decades past, which rewarded those with the patience to find bargain companies, could provide welcome relief for many active investors and managers long trounced by index funds.
But a more enduring recovery might not be in the cards yet. As the Journal noted, value stocks for now do not seem to showcase the hallmarks of quality such as stable earnings, low debt, and highly profitable capital investments that appeared to be major drivers of long-run excess returns.
“Indeed, the value rebound has already fizzled out over the past week,” the report said.
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The sputtering energy in value trades is the latest in a series of moves that could be traced back to August, when investors rushed into bonds in part due to pessimistic headlines about U.S.-China trade relations. As bonds fell back this month, many portfolio managers likely also pared back on their holdings of the best-performing shares, which sapped the momentum that had made low-risk, high-quality stocks market leaders.
The rebound in value appears to have been indiscriminate. “Value names with low quality and high leverage also came back up,” Emmanuel Hauptmann, fund manager and founding partner at RAM Active Investments in Switzerland, told the Journal.
A substantive amount of evidence suggests that safe stocks, regardless of whether they are expensive or not, tend to outperform the market. Risky shares tend to be overbought relative to their returns, research indicates; this may be due to overconfidence, or the fact that betting on a stock is technically easier than betting against it.
A look at the MSCI World Quality Index shows that it has returned 2,100% over the last 30 years, handily outpacing the broader index’s 650%. That’s a problem for value, which the Journal noted has been negatively correlated with quality since 2009. Post-financial crisis growth stocks, meanwhile, have enjoyed a positive correlation with quality; put another way, investors are perceiving safety in companies with the best growth prospects.
The reality of record-low long-term yields, coupled with subdued inflation, has likely fueled the current appetite for future revenue streams promised by growth companies. The rewards of growth are especially handsome for digital technology companies, whose success is especially dependent on the number of people using their services.
“As long as these trends stay around, investors would be unwise to bet on a renaissance in value investing,” the Journal said.
