In 1999, a media personality stated that “investing like Warren Buffett was like driving dad’s old Pontiac.” Of course, that was at the height of the Dot.com bubble, and soon after, “value investing” paid off. Unfortunately, it didn’t stick.
The Widow-Maker Trade
It wasn’t just 1999. In 2007, individuals were chasing the “momentum” in the real estate market. Individuals left their jobs to pursue riches in housing. They were willing to “pay any price” under the assumption they would be able to sell higher. Of course, it was not long after Ben Bernanke uttered the words “the subprime market is contained,” the dreams of riches evaporated like a “morning mist.”
In 2020, investors are again chasing “growth at any price” and rationalizing overpaying for growth. As I discussed in the “Death Of Fundamentals:”
“Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”
Chart updated as of November 2020
Given the massive government and Federal Reserve interventions over the last decade, it should be of no surprise that “growth” has outperformed. For “value investors,” it has been a “decade of pain.” The rise of passive indexing, algorithmic trading, and massive amounts of liquidity have destroyed price discovery in the markets.
Reasons for Under-Performance
In a recent discussion on “Value Is Dead,” we referenced a Research Affiliates article that noted the under-performance reasons.
“An investment strategy, style, or factor can suffer a period of underperformance for many reasons.
First, the style may have been a product of data mining, only working during its backtest because of overfitting.
Second, structural changes in the market could render the factor newly irrelevant.
Third, the trade can get crowded, leading to distorted prices and low or negative expected returns.
Fourth, recent performance may disappoint because the style or factor is becoming cheaper as it plumbs new lows in relative valuation.
Finally, flagging performance might be a result of a left-tail outlier or pure bad luck.
If the first three reasons imply the style no longer works, and will not likely benefit investors in the future, the last two reasons have no such implications.
With today’s value vs. growth valuation gap at an extreme (the 100th percentile of historical relative valuations), it sets the stage for a potentially historic outperformance of value relative to growth over the coming decade.”
The underperformance is quite stunning. The chart shows the difference in the performance of the “value vs growth” index. The index compares the pure value to a pure growth index, with each based on a $100 investment. While value investing always provides consistent returns, there are times when growth outperforms value. The periods when “value investing” has the most significant outperformance, as noted by the “blue shaded” areas, are notable.
When things ultimately go “pear-shaped,” the return to value tends to be a swift event. For investors, it is crucial to grasp what decades of investment experience tell us about the future. When the cycle turns, we have little doubt the value-growth relationship will revert to its long-term mean.
Is the Vaccine Announcement the Turning Point?
Recently, Kevin Muir published a piece with an important message:
“The virus is done. The scientists won. They nailed it…markets will look through any (short-term) negatives and realize the end is in sight.”
He goes on to make a case for “why” the Pfizer vaccine (and the other vaccines that will follow) may be the “silver bullet” that the market has been waiting for. Kevin’s view is the market is a discounting mechanism, and the “Smart Money” will focus on the future. Primarily, he hopes, the “Buying Value/Selling Growth” trade, which has been a widow-maker trade for the past 20 years, will be changed by the “vaccine.”
I doubt the “vaccine” will cure the ills of “value” any time soon as it does not address the primary issues driving the “momentum chase” currently. Refer back to the Research Affiliates comments above.
Does a vaccine change:
The effect of “data mining” on investment styles? No.
The “structural changes” to the market (i.e. proliferation of ETF’s)? No.
A crowded trade that leads to a distortion of prices? No.
The “vaccine” does not cure the most massive problem for value stocks – actual value.
The Lack of Value In “Value”
As a “fundamental” and “value” based investor, the lack of performance in value versus growth has undoubtedly been frustrating. However, one of the biggest problems is the astonishing lack of value in “value.”
The chart is pretty stunning but needs some explanation.
Here is the issue with intangible assets.
“Intangible assets are typically nonphysical assets used over the long-term. Intangible assets are often intellectual assets. Proper valuation and accounting of intangible assets are often problematic. Such is due in large part to how intangible assets are handled. The difficulty assigning value stems from the uncertainty of their future benefits. Also, the useful life of an intangible asset can be either identifiable or non-identifiable. Most intangible assets are long-term assets meaning they have a useful life of more than a year.” – Investopedia
Read the bolded sentence again.
In many cases, the value of intangible assets is often overly optimistic assumptions about the companies worth. We recently quoted Raconteur on this particular issue:
“Tangible assets are easy to value. They’re typically physical assets with finite monetary values, but over the years have become a smaller part of a company’s total worth. Technology disruption continues in artificial intelligence, robotics and cloud computing. As such, intangible assets have grown to represent the lion’s share of corporate valuations. But without a physical form and the ability to easily convert them into cash, working out what these assets are truly worth can be challenging.”