Sept. 26, 2019 8:29 am ET
Together with flying cars, colonies on Mars and four-day workweeks, the comeback of “value” stocks is one of those evergreen predictions that never seems to happen. There are few signs that this time will be the exception.
In recent weeks, developed-market companies with shares that trade cheaply relative to their forecast earnings have suddenly started doing well. The MSCI World Value Index has returned almost 4% on the month, compared with 2% for the broader index and just 1% for “growth” stocks—those that are expensive relative to earnings due to growth hopes.
Investors are paying attention because the longer-term trend is in the opposite direction. Value shares have been massive underperformers since the 2008 financial crisis—even stripping the financial industry out of the calculation. Actively managed funds want to believe that this month’s reversal marks the start of a return to the good old market of the 2000s, which rewarded bargain hunters.
But this is likely wishful thinking. For now, value stocks seem to lack the classic measures of quality—which are always hard to pin down, but include stable earnings, low debt and highly profitable capital investments—that appear to be key drivers of excess returns over the long run. Indeed, the value rebound has already fizzled out over the past week.
September’s moves have mostly to do with a loss of momentum among low-risk, high-quality stocks that were previously leading the market. In August, investors rushed headlong into bonds, partly in response to gloomy headlines about the U.S.-China trade war. When bonds fell back this month, many portfolio managers likely also trimmed their exposure to the best-performing shares, which tended to be in companies seen as safe.
The rebound hasn’t been selective. “Value names with low quality and high leverage also came back up,” says Emmanuel Hauptmann, a fund manager and founding partner at Switzerland-based RAM Active Investments, who holds portfolios biased toward value stocks.
Over the long term, there is substantive evidence that safe stocks outperform the market—even if they are expensive. Research shows that risky shares tend to be overbought relative to the returns they offer, perhaps because investors are overconfident or because it is technically easier to bet in favor of a stock than against it.
Whatever the reason, the MSCI World Quality Index has returned 2,100% over the last 30 years, compared with 650% for the broader index.
Therein lies the problem for value stocks today. Before the financial crisis, quality shares showed only tenuous links to value or growth shares. Since 2009, though, quality has become positively correlated with growth and negatively correlated with value. Another way to think about this is that the safer companies have become those that have the best growth prospects, not those delivering earnings right now.
Many factors have likely played into this. Record-low long-term yields and subdued inflation—both of which are becoming accepted by investors as structural realities of the postcrisis world—make future revenue streams more attractive. Also, digital technology places even higher rewards on growth: The success of companies like Google and Facebook depends—even more than for traditional businesses—on how many people use their services.
As long as these trends stay around, investors would be unwise to bet on a renaissance in value investing.
Write to Jon Sindreu at [email protected]
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