Is Value Still Value?

Two years ago in my blog Red Alert: Value is Value I looked at the extraordinarily long period of time that value stocks had underperformed growth stocks. I was looking to answer the question of whether it was time for the trend to change. The conclusion was that “we are getting close to when value should start outperforming growth for an extended period.” The trend lasted a few months longer and then became range bound, until the more speculative areas of the market peaked. Since then, value has outperformed growth and the question is, again based on historical data, does it have further to run?

Data Divergence

In line with the original blog, I am using the methodology of the Russell 1000 index to define U.S. value stocks and growth stocks. The Russell 1000 index includes the top 1000 companies by market capitalization in the U.S. From the companies in the index, Russell uses three metrics to derive the Russell 1000 Value Index and the Russell 1000 Growth Index. In addition to the classic value metric of stock or index price divided by book value, they look at expected growth from stock analysts’ estimates and historical sales per share.

Zooming In

As you know, a lot has happened in the stock markets over the last two years. Stocks kept going up until we headed into 2022, fueled by the recovery from Covid and the related massive stimulus from government spending and central banks easing monetary conditions. During this time value stocks first underperformed growth stocks, then the trend went the other way.

In chart 1 below I show the ratio of the total return index for the Russell 1000 Value index to the total return index for the Russell 1000 Growth Index[1]. When the line is falling growth is outperforming value, and when it is going up value is outperforming growth.

Chart 1

Source: FTSE Russell

Following the blog in June 2020, value’s performance vs. growth bottomed in the fall of 2020, recovered a bit, then bottomed again when the technology-heavy NASDAQ index peaked in late November 2021. Subsequently, value has been outperforming growth. While value stocks have protected investors’ capital better, unfortunately they have done that by losing less money than growth stocks! Since the end of November 2021, the Russell 1000 Value index is down 7% and the growth index is down 27%. That’s a ton of value for value.

Zooming Out

Now let’s step back and look at the longer-term picture. Chart 2 is from the original blog, updated to the end of June, to see if we are still in the “Red Zone”. The red shading on the chart shows the 5% of the times when the ratio of value to growth has been at its lowest. In other words, when value has been extremely cheap. Based on this method, value was cheapest around the time of the technology bubble in the late 1990’s to the early 2000’s and again during the Covid bubble from mid 2020 to late 2021.

Chart 2

Source: FTSE Russell

With the last data point at the end of June 2022, value has risen out of the “Red Zone”. But as you can see, it is still on the cheap end of the range. To put a number on it, value has only been cheaper relative to growth 14% of the time.

Related Reasoning

Detailed and disciplined work has been down on this topic by two top tier quantitative asset management firms in the U.S., AQR Capital and Research Affiliates. Both firms say their data and analysis points to value continuing to outperform growth, as covered in this Wall Street Journal article Value Investors Bet Recent Market Leadership Is Just the Start. In addition, the highly respected value manager GMO LLC says that while the growth bubble, relative to value, has “…deflated somewhat, it has yet to fully burst” in their research note Time To Jump Aboard The Value Train. Note that these firms believe the optimal strategy is to go short select growth stocks versus going long select value stocks, a sophisticated strategy that should only be managed by investment firms with the appropriate experience and track record.

Value Is Still Value

We know that investing is more art than science – we can’t predict what will happen. But we should pay attention when the odds favour tilting our portfolio in a certain direction. The stock market continues to struggle with the combination of high inflation, higher rates, government spending down from its peak, and economic growth slowing if not heading into recession. During these times investors place more value on quality, dividend paying companies trading at more reasonable valuations. On the flip side, growth companies trading on the promise of future revenue or profits fall out of favour. When you combine this with the data showing value is cheap, the odds right now tell us that the trend is for value to continue outperforming growth. Just remember that that doesn’t necessarily mean value stocks will have a positive return if the bear market continues!

Invest wisely,

Dave Schaffner, CFA

Principal, Wayfairer Capital Management Ltd.

[1] Comparable results are obtained by using the ratio of IWD, the iShares Russell 1000 Value ETF, versus IWF, the iShares Russell 1000 Growth ETF, but there is less history as the ETFs were launched in May 2000