Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., May 30, 2019.
Brendan McDermid | Reuters
Value investing might have lost its value.
The classic factor investing strategy of picking stocks with cheap book valuation, embraced by the legendary Warren Buffett, has become increasingly irrelevant thanks to central banks and technology, according to AB Bernstein.
The long period of low interest rates is the first to blame for the demise of value investing, Bernstein said. The Federal Reserve started its quantitative easing program to salvage the economy from the 2008 recession. But at the same time, an easier monetary policy lifted valuations across the board, leaving a smaller premium on cheap stocks, hence the long stretch of underperformance of value names.
Take iShares S&P 500 Value ETF, an exchange-traded fund that tracks the undervalued stocks in the S&P 500. It has been consistently lagging the market in the last five years.
“Duration has been bid up as rates are so low,” Inigo Fraser-Jenkins, Bernstein’s head of European quantitative strategy, said in a note on Wednesday. “Thus, the outperformance of value might require higher interest rates, which could be structurally difficult to achieve in the foreseeable future. In this sense one could say that QE could have stopped the mean-reversion process that usually occurs over the economic cycle.”
Most of the decade-long bull run has been led by a boom in shares of major tech companies which are disrupting traditional industries. Their dominance has ruined the economic moats of many industries. Popularized by Buffett, moats are the competitive advantage a company has over new entrants and its rivals which protect its market share and profitability.
“If Amazon is going to continue to destroy other parts of the retail sector, say, then why should we expect mean-reversion to still hold? We agree that this dynamic is likely behind part of the underperformance of value,” Fraser-Jenkins said. “Technology has disrupted industries in a way that may permanently destroy ‘moats’ that used to exist around certain industries.”
Value investors also got burned by the massive rotation to growth stocks as appetite for fast-growing companies like tech surged. The trend favoring growth over value still persist in recent years as value names have underperfomed in the past five years.
“Most important growth assets are intangible which in many cases are not captured in book value and retained earnings, making the usefulness of book value and earnings questionable,” Fraser-Jenkins said.
To be sure, this could just be an extra-long period of growth investing outperformance coming as a result of the fallout from a once-in-a-generation financial crisis. Once we return to more normal economic cycles, the two types of investing could begin to take turns again.