I came across a terrific article I wanted to share with you by the asset manager GMO on how extreme the opportunity in value is versus growth. I’m going to share some of the most important commentaries.
“The performance of Value from 2007 to 2019 was, to put it mildly, uninspiring. This was not altogether surprising, considering the run-up that Value had prior to that period. We at GMO did warn of the peril of investing in cheap stocks at a time when their valuations relative to the broad market looked to be at a record high. But the mind-numbing pain of holding Value anywhere in the world over the last 12 months has been something else entirely – it has shattered the record losses of the factor over any year-long period, tech bubble included. It is time, then, to repeat our message from last year, though this time more forcefully: no matter where you look, no matter how you slice it, Value looks cheap.
If Value stocks are extremely cheap versus the market, it is necessarily the case that Growth stocks are very expensive. In absolute terms, that is even more true, given that the overall market is trading at elevated valuations relative to history. Exhibit 9 shows the median price/sales of the Growth half of the U.S. stock market, and Exhibit 10 shows their median P/E. On a price/sales basis, Growth stocks are even more expensive than they were in 2000, and while they are not quite as extreme on a P/E basis, they are certainly far more expensive than any time before or since.
At what point do you call that a bubble? While Growth stocks and the market as a whole have been quite expensive for several years now, Jeremy Grantham has frequently been at pains to remind us that there is more to an investment bubble than elevated valuations. According to him, what the true investment bubbles have in common is a mania on the part of market participants and a sense that if people would only jump on board, “Everybody Ought to be Rich.”
With a combination of some the highest valuations ever seen and clear corresponding manic investor behavior, it seems clear to us that Growth stocks are indeed in a bubble.
If it is indeed the case that widespread vaccination allows the world to come back to something like normal by the end of 2021, it seems very likely be a continuing net positive for Value. Given the scale of the discount at which Value stocks are trading, the move from that alone could be quite large. A potential further catalyst in that vein would be interest rates rising above today’s rock-bottom levels. Even a relatively small upward move would be positive for sectors such as Financials, which are overwhelmingly Value stocks.
But our belief in Value from here is not driven by a belief in any of these potential catalysts per se. That is partially because we don’t think we are particularly good macroeconomic forecasters, but mostly because even in hindsight the catalysts for market turns are often obscure. The cause of the 1929 and 1987 market crashes, the downfall of the Japanese equity market in 1989, and the bursting of the Tech, Media, and Telecom bubble of 2000 aren’t particularly obvious even decades after they occurred.
And even if you knew what the economic catalyst for the turn was going to be, determining when you would want to take the leap into Value would be far from clear. At times the market looks ahead to the future state of the economy. At other times, it doesn’t even seem to pay much attention to what is going on in the present, let alone the future. Future financial historians may indeed declare that the release of the vaccine trial data in November 2020 marked the start of the great Value rally of the 2020s. On the other hand, they may not. We are far more confident that something will cause the turn than any one thing in particular will. Given the extreme level of the opportunity in Value today, we consider that the risk of staying on the sideline until the turn is obvious is a bigger risk than entering into the trade before we are 100% sure the bottom is in.
It has truly been a hellish time for Value. After years of disappointing investors, Value just experienced its worst 12-month performance in history. The long history of Value as a style shows that its best times are more or less always preceded by pain. As Value investors who have been suffering for it for over a decade, we can certainly attest that we have experienced enough pain to justify a wonderful run for Value stocks. But you don’t have to simply take it on faith that Value is well set up for better times ahead. The relative valuations of these stocks around the world are some of the cheapest we have ever seen, and a decomposition of the sources of Value’s return since it peaked in 2006 shows that if valuations were to merely be stable at today’s levels and the underlying fundamentals for Value and Growth were the same as they have been over the last 14 years, Value would beat the market by a decent margin.”
Here is the link to the entire article if interested:
https://www.gmo.com/americas/research-library/3q-2020-gmo-quarterly-letter/