By now, you know the story — or at least you should.
If value, as an investment style, was already dead, the pandemic buried it. (“Does anybody want to say a few words?”)
That’s rather macabre, but it’s true. Just ask some value investors. Or consult any of the myriad visuals one can produce to illustrate the point (figure below).
This is the discussion outlined comprehensively in “The Only Debate That Matters“.
Every rotation out of secular growth winners and into cyclical value laggards is generally described using adjectives like “nascent” and “burgeoning”. That’s because, after years of head fakes, nobody is willing to say, definitively, that value is back — that any rotation is sustainable — that finally, at long last, a durable shift is afoot.
It seems as though something always intervenes to short-circuit these nascent regime shifts. For example, late last year, many were convinced that with the “phase one” US-China trade deal in place, and central banks having spent the better part of 2019 pivoting back towards accommodation, the stage was set for a strong rebound in global growth and inflation, and thereby a pro-cyclical rotation within equities accompanied by higher long-end yields. Then along came a geopolitical land mine (the assassination of Qassem Soleimani) and on its heels, “a great and powerful plague” (to quote Donald Trump).
This debate is perhaps more pressing now than ever for one simple reason: leadership has narrowed so much during the post-COVID rally that there are very real questions as to whether it’s even possible for benchmarks to rise in an environment where the baton is passed from tech and momentum heavyweights to long-suffering reflation/cyclical names.
The last several sessions for US markets are a testament to those concerns. Tech underperformed and while it’s plausible to suggest that had crude not rolled over at the same time, cyclicals and value would have done a better job offsetting the slump, the reality is this: so goes FAAMG, so goes the market.
As detailed extensively here on too many occasions to count, this is all tied up with the long-running “duration infatuation” in rates, and the extent to which secular growth favorites (e.g., big-cap tech) are tethered to falling yields, a flatter curve, and a macro environment like that which has prevailed for the better part of a decade.
The pandemic turbocharged all of that, adding insult to injury for value.
“The last ten years have been even worse for value investors than the dot-com bubble, with the worst returns in history for US value stocks relative to growth”, BofA writes, in a note dated Tuesday.
The bank goes on to underscore the notion that this is “all one trade”.
More than three-quarters of value’s relative performance versus growth is explainable by rates, inflation, and the business cycle, BofA says, before noting that “all the dominant positions in the 2010s – growth, large caps, US, US$ – are plays on more deflation [and] without a big macro shift will probably keep winning”.
Indeed, the post-COVID trade has been especially vexing for value investors given that relative performance failed to respond to rebounding crude prices and, relatedly, rising inflation expectations (figure below).
Everything said above has a decidedly fatalistic feel to it. Indeed, BofA takes a look at history and notes that over eight decades through 2007, there were 16 periods during which value outperformed “sustainably”. Those stretches lasted, on average, more than three years. Over the last decade, by contrast, there have been two value “bull markets”, lasting an average of only 22 months, with returns well short of those seen during historical stretches of outperformance.
“All this suggests that the value factor as traditionally understood is broken”, BofA concedes, in the course of writing that “until the macro environment changes, we would expect the winners of the 2000s and 2010s to keep winning and to stay crowded”.
The visual on the right (below) is especially striking.
The bottom line, the bank’s Jared Woodard says, is that “there is no alternative in a world of shrinking returns on capital, as plunging discount rates and excess liquidity push the value of long-term cash flows toward infinity”.