At Oversold Levels, Value Stocks Pique Interest
We focused on Geopolitical Risk for the last three issues — including the ever-evolving coronavirus story that has grabbed global headlines in recent months.
Last week’s column looked at Geopolitical Risk as a tool for both risk management and stock selection.
The week’s column focuses on the highly anticipated return of value as a profitable investing strategy. Long out of favor, investors – and particularly bewildered value investors – are raising the question if value stocks are finally oversold and if now is finally the time for value to triumphantly return to favor.
Dubravko Lakos-Bujas, J.P. Morgan’s chief U.S. equity strategist, noted last month that value had experienced a rally and had outperformed momentum in the previous six months. And there’s still room to run, he said, as the sector rotation into value is only about 42% complete. Value remains “cheap” and “oversold,” he said.
This topic has been heating up in the Omega Point community. Several managers we’ve spoken with believe in the oversold story. The discussion piqued our interest. Consequently, we ran the numbers in Omega Point to gain greater insight into the value story.
It should be noted that value has had an extremely rough time. Comparing the S&P 500 Growth and Value indexes for the 10-year period, ending Dec. 31, 2019, Value not only lost money in that period, but it also underperformed growth by more than 80%.
In an industry characterized by organized conflict, there are various conflicting definitions of Value. That said, Book-to-price has been a consistent metric cited in financial journals, so we will use that metric in the following analysis below.
To cast a quantitative lens on the discussions we had with various investment managers, we created a US-focused portfolio that took the top 2,000 stocks in the Russell 3000 index (excluding ETFs and ADRs), as ranked by market capitalization. We then ranked each stock by its Value factor score. From that list, we created a $100 million portfolio and bought (went long) the 500 stocks with the highest value factor scores. The long side was equal weighted and each stock bought was 20 basis points of the initial portfolio.
Conversely, we then created the short side of this market neutral portfolio by selling the 500 names with the lowest value factor scores, selling $100 million worth of stock, also equal weighted at 20 basis points.
This portfolio was rebalanced on the 1st trading day of each month starting January 1997 (using the above process) through January 2020.
We then repeated this process using MSCI’s ACWI to construct a global portfolio to compare versus the US Portfolio.
Here is what we found.
The Value Portfolios
US / Global
Performance since 1997 - US Value Long/Short Portfolio
The portfolio realized a total return of only 9% since 1997, which represents less than a 0.4% annualized return.
Value has clearly had a tough run.
US Portfolio: Tops, Bottoms & Drawdowns
- The portfolio’s Jan 1997 start date landed it square in the middle of the Dot-Com Boom of 1994-2000, when value stocks received almost no love from tech-obsessed traders and investors. By the time the tech bubble finally burst in early 2000, 62.3% of the portfolio’s beginning value had also vanished into thin air.
- The portfolio then staged an impressive comeback, peaking at +139% by January 2007, when the party hit a brick wall as the Subprime Mortgage Crisis ripped through the markets. Once the dust settled 1 ½ years later, the portfolio was down close to 50% from its most recent peak.
- Investors still stinging from the crisis poured into value early, and helped march the portfolio to a new peak on May 3, 2010. Unfortunately for most value investors, that was the very last peak they ever saw, according to our portfolio.
- Post-2010 has continued, with a few shorter-term exceptions, as a losing period for value investors. They would be down 87.7% today, which coincidently is a bottom, based on our analysis.
- This 10-year top-to-bottom is the largest historical drop in value we’ve seen in any period since 1997 — bigger than either the dotcom bubble or the subprime mortgage crisis.
Peformance since 1997 - Global Value Long/Short Portfolio
Total return was also dismal for the Global Portfolio, but it did outperform its US counterpart, realizing a total return of 44.9%. (1.6% annualized)
Global Portfolio: Tops, Bottoms & Drawdowns
- The dotcom bubble also hit the Global Portfolio hard, erasing 48.3% of its initial value, which was a bit less severe than the US Portfolio.
- The Global Portfolio outshined the US over the next seven years, hitting +155% by April 2007, when the Subprime Mortgage Crisis spread into the global markets. But on the flipside, it gave back more on the way down than the US Portfolio, and bottomed out close to 60% vs. its prior peak.
- The post-subprime bounceback was slighter than the US, but still up an impressive 57%
- Similar to the US, Post-2010 has also been a fairly steady descent in performance for the Global Portfolio, down -60.7% and sitting at a current bottom as well.
- While nowhere near the magnitude of the US Portfolio’s drawdown (-60.7% vs. -87.7%), since 2010 the Global Portfolio’s drawdown still exceeds that of the dotcom bubble or subprime mortgage crisis.
US and Global Value Spread
The performance of both the US and Global portfolios have generally moved in the same direction, with a few exceptions, throughout the period we analyzed.
However, the spreads between the US and Global portfolio were in constant flux.
In June 2014, the US and Global portfolios were roughly equal.
Since June 2014:
- US is down by 70%
- Global is down by 34%
- The spread has swelled from 0 to 3600 basis points.
A study of the historical drivers behind this seesawing spread will require a deeper dive and is beyond our scope here today. But it certainly deserves an in-depth analysis in the future. We are noting these observations as some industry analysts rely on this type of spread analysis as an indicator of forthcoming trend reversals.
As always, we encourage you to reach out to Omega Point if you’d like to take a deeper dive into any of the data we analyze and present in our Factor Spotlight newsletter.
The Value Portfolio - Style Characteristics
We continue with our analysis to explore style characteristics of the Value portfolio. Our focus on style for this week will be exclusive to the US Portfolio. We have set a new start date to match the most recent peak (March 2010). This eliminates previous shocks and disruptions less relevant to the existing market environment.
So what are some common attributes of “Value Stocks” that we can infer from the above analysis?
Value stocks tend to be:
- ‘Cheap’ relative to their book value (Orange Line - Long ‘Value’)
- Pay out dividends (Blue Line - Long ‘Dividend Yield’)
- Have low leverage (Red Line - Short ‘Leverage’)
Maybe that’s what many of you already suspected, but at least you now have some hard data to settle any remaining arguments such as the one in the following hypothetical scenario involving two stock pickers - John and Mike:
John: I just put a nice chunk of my portfolio into the best value stock in the market!
Mike: Great to hear, but how does its value factor compare to other names?
John: I believe it’s in the upper 10%.
Mike: Good for you, but I found a name where the value factor is #1 on the Russell 3000!
John: Very impressive Mike, but don’t forget that value is also driven by other factors such as dividends and low leverage.
John: And mine stacks up the best according to the Omega Point models.
Mike: Ok you win for now John, but let’s check back in a year.
The final point that Mike is making in the scenario above is that the underlying style characteristics of ‘value’ can, and have fluctuated over time. You can see from the chart that dividend yield is a bigger driver of value today than it was just one year ago. And that could easily change again.
Added Bonus: if investors see opportunity in the trend and decide to buy into value today, there are far worse bets than buying into cheap, low-levered, dividend-paying companies.
The Value Portfolio - Sector Characteristics
Many investors tend to hold unwavering views that certain industry sectors are either in the value camp, or they’re not.
Does this black or white perspective hold up under our ‘spotlight’?
The answer is to a degree, but not really.
As we can see in the chart above, sectors rise and fall in “Value” over time.
Between 2010 and 2020:
- The Banking sector (Yellow Line) became increasingly value-oriented.
- The Software sector (Blue Line) and Biotechnology sector (Green Line) each became more “anti-value” oriented, with some whipsaw-like fluctuations from Biotech across the period.
A surprise: The Oil, Gas & Consumable Fuels sector (Red Line) started out anti-value and raced out-of-the-gate to prove it. But since 2011, this energy sector has become increasingly entrenched into the value camp.
There are several takeaways you can readily infer from above. But in a nutshell:
Beware, Value can be Polarizing
If you think you are investing in value by staying within certain industries, don’t lose your focus and turn away for too long, as the sectors with value characteristics can easily change over time. From our analysis of the Global Portfolio, we can confirm that there are additional ‘non-conforming’ sectors’ lurking out there.
So how do we adjust the return drivers of value to construct a more value-friendly portfolio that doesn’t transform into and become more of a sector bet?
As usual, we have some ideas. Stay tuned, and we’ll look at this topic in greater detail in next week’s column.
US & Global Market Summary
US Market: 2/7/20 - 2/13/20
- Although uncertainty about the coronavirus outbreak remained high, the S&P 500 advanced four out of five days last week, ending at an all-time high. All 11 industry groups advanced, led by companies that pay high dividends.
- Investors found comfort in solid economic data, better-than-expected earning reports and a signal that the Federal Reserve stands ready to act if needed.
- Retail sales rose or a fourth consecutive month as cheaper gas prices encouraged Americans to spend on other goods, putting consumers on track to support further economic growth.
- Heading into Presidents’ Day week, Walmart and Machinery giant Deere & Co. are set to issue quarterly results updates.
Factor Update: Axioma US Equity Risk Model (AX-US4)
- Staying true to the theme of this week’s Factor Spotlight, the rotation out of Valuecontinues unabated in the US Model, and is by far the most oversold factor.
- Earnings Yield continued its 2 week march back from oversold territory, and edged out Size as the week’s biggest positive mover.
- Market Sensitivity saw positive movement at long last, and in the process decoupled from its multi-week tandem slide with Volatility, which falls once again this week.
- Although still falling for the second week in a row, it appears the brakes were applied to Profitability’s abrupt tumble last week.
- Growth saw a slight dip again, but remains in Overbought territory.
- US Total Risk (using the Russell 3000 as proxy) fell -0.27%.
Factor Update: Axioma WorldWide Equity Risk Model (AX-WW4)
- After being one of only three up-movers in the global model last week, Size has really put the pedal to the metal this week as it swiftly exited negative territory.
- Another up-mover from last week, Earnings Yield, also jumped out the gate and was barely nosed out by Market Sensitivity as this week’s #2 positive mover.
- Still deeply oversold, Value eked out some long overdue positive movement this week.
- Profitability continues its 3-week slide even deeper into negative territory.
- Global Risk (using the ACWI as proxy) fell -0.24% this week, almost completely reversing its rise last week.