Is Value Investing Dead?
The Demise of Value Investing.
Value investing is struggling to remain relevant.
These are all headlines from the end of the decade after an incredibly strong period for growth stocks. Many would say that investors were happily dancing on the graves of value stocks as their portfolios climbed beyond their wildest beliefs. The media narrative has not changed much since the beginning of the new decade. Technology commentary continues to dominate the media headlines, and who is to blame them? The growth potential for AI is much more exciting to learn and read about than the fundamentals of Coca-Cola.
Investing in fundamentals has never been loud or exciting, but it has provided consistent returns over long periods of time. Over the last three years, we were aware that value was having a strong run, likely somewhere near growth equities, but growth was likely winning due to AI, tech dominance, chip shortage, etc. While the narrative in the media may not have changed, the shift from growth to value has already begun. When discovering it was strongly opposite to what we believed, we decided to survey 31 financial professionals who deal with high-net-worth families throughout Canada. Our thesis was correct; even though value has dominated the three-year period, a majority (71%) of financial professionals believe growth has been the stronger factor.
This is to no fault of the investor; there are many behavioural biases at play here, with the most dominant one being the availability bias – also known as recency bias. Our recent encounters with investing, especially over the past decade, and exposure to media content have heavily leaned towards discussions of growth. This has left the door wide open for value investors to quietly outperform. Given the inherent biases in investing, it is crucial to remain steadfast in your convictions and resist anchoring to media-driven narratives.
While the three-year view looks very strong for value (S&P 500 Value +44% vs S&P 500 Growth +21%), growth has outperformed value in two of the three calendar years below. Not by as much as you might think, but growth did outperform. 2022, the year rate hikes began, was a big reason for the outperformance over the period, with value outperforming growth by 24% (S&P 500 Value -5% vs S&P 500 Growth -29%). But that is what value is meant to do; when you get this larger pullback in the market, your blue-chip value stocks should hold up better. Lucky for us, calendar years are arbitrary; as long-term investors, we are focused on exactly that – the long-term – and this type of portfolio construction is proving to be beneficial given the current market environment.
Portfolio Positioning
We have intentionally maintained a portfolio stance that is underweight in growth equities for a considerable period. We have done this mainly by prioritizing dividends, equal weighting in the US market, and employing active managers who prioritize earnings and cash flow. While we acknowledge that being overweight in value stocks was not the optimal choice for quite some time, there were numerous challenging periods where sticking to our viewpoint was difficult; nevertheless, our patience and commitment are yielding positive results.
Our overall positioning in the portfolio is best characterized as ‘moderately defensive.’ The market is currently pricing in a rather goldilocks scenario of a soft or no landing for the global economy with a potential lift from rate cuts, which are continuously being pushed out. We anticipate bumps in the road and have fortified many portfolio components with defensive measures. While growth, more specifically quality, has shown some resilience in challenging economic times, we remain tilted towards value investments to mitigate potential downturns effectively.
While we have been enjoying a successful tilt for the past few years, the primary focus should be on what will happen in the future. A few key reasons lead us to believe there will be continued outperformance of value:
I. Sustainability
The sustainability factor comes down to good old-fashioned diversification. Unsurprisingly, approximately 90% of the return for the growth index throughout these three years can be attributed to one sector: Technology. Flipping over the value index, to achieve the same 90% coverage for return, you must include the top seven performing sectors of the index. While there are certainly differing opinions in the investing world, there is likely a preference for investment growth to be diversified amongst seven sectors rather than depending solely on a single one. This type of investment growth does not feel particularly sustainable over the long run.
II. Valuations
Simply put, the US growth index is expensive, and as we learned in a recent Market Ethos (Do Valuations Matter?), the more expensive the index, the lower the forward returns have been historically. The growth premium has made its way back to nosebleed levels last seen in 2021. While the markets moved much higher throughout Q4 of 2023, mainly due to multiple expansions, price does not entirely explain the quick shift in valuations we saw at the end of December. The more impactful explanation for the return of the growth premium comes down to forward earnings estimates. The earnings estimates for growth companies in the S&P 500 pulled back while the forward earnings estimates for value in the S&P 500 strengthened. Therefore, a significant amount of the P/E growth premium climbing has to do with the “E” moving in opposite directions for both styles. We expect that trend to continue as some of the earnings estimates for the growth companies were/are certainly extended.
III. Higher inflation & rates
While the current inflation level has come back down, our view is that it will continue to flare up through the cycle and, on average, remain at higher levels than the last cycle. Looking back over the last 48 years, this has proved positive for the value factor. There was roughly the same number of periods when US CPI was greater than 3% as there was when CPI was less than 3%. Separating those two periods, value stocks outperformed on an average monthly basis by +25 bps in periods where US CPI was greater than 3%. The opposite can be said for periods where US CPI was less than 3%; growth outperformed value by +23 bps. During a period of rate cuts, we can expect growth to outperform value. However, if inflation proves more volatile over the long term, so will the rate environment, meaning we may not be going back to the depths of interest rates. A more consistently elevated rate environment should prove to be a boon for value.
Final Thoughts
Recognizing new cycles early on is crucial for maximizing future returns. After a decade of underperformance in value, the time for value investors may have arrived. While the US equity market has distinct value and growth factors, other markets, such as the TSX and international markets, appear value-heavy based on current valuations. This forms the basis for our underweight position in the growth-heavy US market, market-weight in Canada, and overweight in international equities.
While we acknowledge the possibility of mixed performance between value and growth for the remainder of 2024, our preference leans towards value, aligning with our forward-looking strategy. Our stance doesn’t imply a complete dismissal of the growth factor. We remain cautious about potential challenges, such as a recession, where growth may exhibit some resilience. However, our focus is on anticipating future trends, and currently, that points towards a value-oriented approach. Spread the word – value is on the rise, and we aim to keep this momentum for the dedicated value investor.
— Brett Gustafson is a Portfolio Analyst at Purpose Investments
Insights with Purpose
At Purpose, we are attempting to change the status quo within the investment industry – mainly the enigmatic standards by which the industry operates. We are an open book when it comes to portfolio design and discussions surrounding our outlook and strategies. We want to make managing portfolios simpler for advisors and act as a sounding board for ideas. We start by running portfolio comparisons between your portfolios and ours. Not to say ours is right and what you are doing is wrong, but to understand the differences and have discussions surrounding the rationales. We aim to keep this discussion going quarterly; this is not a one-and-done service. We want to build our relationships with advisors so that the end client has a satisfactory investment experience.
If you want to know what exposures your portfolio is tilted toward, feel free to reach out to our team. As the great Peter Lynch once said, “Know what you own and why you own it.”
Sources: Charts are sourced to Bloomberg L.P.
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