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Value investing is dead. At least, that’s what people say.
If I’m honest, I’m not sure value investing is ever considered to be alive. Even when it’s working, it’s usually treated as a temporary aberration.
That’s because it goes against the grain. It always involves investing in what’s unpopular.
So by definition, it is never going to be flavour of the month for long.
Yet we could be entering one of those times.
Value is dead – long live value
Earlier this month, Cliff Asness, founder of AQR Capital Management, said that – even though he’s generally against timing the market – it’s time to take a bigger bet on value stocks.
Why? Because – judged by AQR’s measure – value stocks are now as cheap relative to the broader market as they were during the tech bubble. Other than that brief period in the late 1990s, value is the “cheapest it’s ever been by a fairly decent margin”.
In other words, cheap stocks are very, very cheap indeed compared to the rest of the market.
Sounds good.
But wait. Value has done really badly in the last decade or more. Lots of people say that today’s value stocks are mostly value traps – companies trapped in dead or dying industries. Or that value is too “old school” – it doesn’t take account of the way the internet has changed the corporate world.
Who’s right? I don’t know, but as always, I have opinions. Allow me to share them with you.
On the one hand, the definition of value is often overly simplistic, even if you can pin someone down to exactly what they mean. The various metrics used to define “value” stocks all have their own flaws. “Book value”, for example, is often a poor measure of the value of intangible assets, which are increasingly important in an intangible universe.
On the other hand, I think that you can always find solid-looking critiques to argue that “it’s different this time”. And that’s why I’m not entirely sure that all of today’s apparently solid-looking critiques invalidate the value factor.
It seems to me that, at a fundamental level, the reason “value” works is for the same reason that “momentum” works – investors love popular stuff and they hate unpopular stuff. They happily buy popular stuff even when it gets expensive as a result, and they cheerfully shun unpopular stuff even when it gets dirt cheap as a result.
This is a core part of human nature. So it doesn’t matter how much we “know” that we should buy cheap stocks. Our brains are simply not wired to feel comfortable investing in stuff that no one else likes. So instead of doing so, we’ll find all kinds of apparently valid reasons to avoid it.
Why would value start outperforming now?
The only real question is: what catalyses the shift from one to the other? What happens to make people believe that the popular stocks have risen too far, and that they should be buying the unpopular stuff instead?
That’s incredibly hard to spot, because it boils down to timing the market. Proponents of value would point out that you don’t need to spot the turning point in any case, because if you buy cheap, then you’ll win out in the long run. I’d mostly agree with that.
However, it’s interesting to look at these things as an intellectual exercise, in that it might teach us some useful lessons for the next time value massively underperforms growth for ages.
It’s very clear to me that the underperformance of the stocks considered to be ‘value’ stocks, is a direct result of the bull market in “duration”.
The “duration” bull market is something I discussed briefly with Dylan Grice in this interview. But to sum up, “duration” is a term that’s usually associated with bonds. Put simply, what it measures is: “how long do I have to wait to get paid?” The longer the duration of a bond, the longer it takes to get your money back.
That in turn means that the bond’s price is more sensitive to changes in interest rates. When rates fall, the price of a bond usually goes up. When rates rise, the price of a bond usually goes down. The higher the duration, the bigger the move.
A bond with a maturity date far into the future has a higher duration than one that matures tomorrow. A bond with a low coupon (annual payout) has a higher duration than one with a high coupon (as the lower the coupon, the longer it takes to get your original investment back).
The thing is, you don’t have to restrict this to bonds. You can view other assets in terms of duration too. What would a stock with a high duration be? It’d be one that pays little or no dividend. It might be loss-making, or only making a tiny amount of profit compared to its valuation. In other words, a growth stock.
What would a low duration share be? One that probably paid a relatively high dividend, and that traded on a low price/earnings multiple (in other words, one where you don’t have to pay much per £1 of earnings). In other words, a value stock.
Now, the most obvious feature of our investment environment right now is that interest rates have been falling for decades. In turn, that means that assets with high duration have been very attractive and have done very well.
Yet in recent months, we’ve seen what may – or may not – amount to a panic surge in bond yields, which has now given way to a much more “risk-on” environment.
In other words, interest rates spiked lower in August, and since then they’ve been rising gently. And alongside them, value stocks have started to make a comeback.
Will it last? It might. It might not. But in the long run, I’ll always feel happier buying cheap stuff than expensive stuff. We’re really only discussing this now because it might actually be time for the cheap stuff to actually start performing.
Where should you invest if you’re looking for value? The UK has been a good one for a while now. But you might also want to look at Japan. My colleague Merryn did just that in the current issue of MoneyWeek magazine, and she found plenty of exciting opportunities out there. If you’re not already a subscriber, get your first 12 issues free here.