- No anomaly has generated as much interest (or controversy) as the value premium, or the finding that over the long run, value stocks outperform growth stocks.
- There is convincing evidence that earnings for value companies implode in recessions and recover correspondingly sharply in recoveries.
- I expect value to outperform growth.
While FFTW focuses primarily on fixed income, we find it interesting to take an occasional look at equity markets on account of the significant linkages between the two markets. This commentary focuses on the equity markets.
Value: the finding that over the long run, value stocks tend to outperform growth stocks
Both the source and the magnitude of this outperformance have been hotly debated, with most debaters falling into one of two camps. Those who believe that the higher return of value stocks are compensation for some unseen risk (perhaps they carry with them some tail risk that materializes when the economy hits a particularly bad patch, as it did in 2008), and those who believe that the higher return of value stocks are a reflection of human frailties, and accrues on account of systematic biases in investors’ behavior. We might call the first camp the Fama-French camp, and the second the Lakonishok camp.
The truth probably lies between these two extremes, though I must confess that I lean toward the first group because I have seen convincing evidence that earnings for value companies do implode in recessions, and recover correspondingly sharply in recoveries. In fact, it can be shown mathematically that over the very long term, growth and value indices must experience the same rate of per-share earnings growth, and hence the same price return. Any difference in total return is driven entirely by the difference in their dividend yield. But math is math and markets are markets, and in the long run, as Keynes famously remarked, we are all dead, sometimes because of what markets do to us in the short run.
The past seven and a half years have not been kind to the theory. From the end of 2008 to last Friday (see exhibit 1 below), the Russell 1000 Growth Index has outperformed the Russell 1000 Value Index by about 30%, and the MSCI Emerging Markets Growth Index has outperformed the MSCI Emerging Markets Value Index by about the same amount. While the Stoxx Europe Total Market Growth Index has outperformed the Stoxx Europe Total Market Value Index by a staggering 60%. These differences are for price returns; accounting for differences in dividend yields lowers the performance differentials to about 20%, 10% and 40% respectively.
Exhibit 1. In the US, emerging market (EM) and Europe, growth stocks outperformed value stocks in the period between 31/12/08 and 24/06/16. Outperformance of growth relative to value is contrary to what financial theory tells us to expect.
The graph shows relative price returns (when the line is rising, growth is outperforming value), for the Russell 1000 Growth Index relative to the corresponding Value Index (yellow line), the MSCI EM Growth Index relative to the corresponding Value Index (green line) and the Stoxx Europe Total Market Growth Index relative to the corresponding Value index (red line). All comparisons are for the period between 31/12/08 and 24/06/16.
Source: Bloomberg as of 24 June 2016
Now the worm appears to be turning…
Since mid-February 2016, as energy and mineral prices have risen, value has outperformed growth in the U.S. and has performed in line with growth in Europe and in emerging markets. Even though the trend reversed sharply on 25 June 2016 in Europe (the day after the Brexit vote – on 24 June 2016 the Stoxx 600 Growth Index outperformed the Stoxx 600 Value Index by 196 basis points).
The reversal was, however, far more muted in the U.S. Just as one swallow does not make a summer, one reversal does not kill a trend. While we have seen false starts to a value rally in the past (in 2012-2013 in the U.S. and in 2013-2014 in Europe), the slowing of economic growth, along with the recovery in energy and commodity prices, has led to a bias in favor of value indices relative to their growth counterparts. On the growth side, scandals at various pharmaceutical companies have soured both the public and Congress on the industry and the exceptional returns of the sector have ground to a halt.
Value: a multi-year winner
In spite of the post-Brexit reversal on 25 June 2016, I expect this worm to continue to turn – the value cycle tends to run for many years although it can be punctuated by bubbles (as in 1999) and market meltdowns (as in 2008).
Picking turning points in the cycle is never easy (it would have been tempting to call a peak in 2013, especially in Europe, but the cycle reversed itself in 2014). Nonetheless, I feel confident in saying that, in spite of the spike on 25 June 2016, the conditions are now in place for the value cycle to reassert itself, and for value stocks to outperform growth stocks for some years to come – long may they run!
This article was written in New York City on 25 June 2016 [divider] [/divider]
Here is a link to another article on value stocks, published earlier in 2016 on Investors’ corner:
Is it time to start buying value stocks, by Sebastian HALLENIUS on 4 March 2016