The recent market crash and ensuing return of risk-on sentiment has led many to once again raise the question of whether value investing is still a valuable (pardon the pun) strategy.
For the last decade or so, it was widely believed that growth investing was a superior approach compared to value investing, and the data seemed to back this up. During good times, investors are more willing to spend a dollar today for something that might be worth two dollars in a year’s time.
However, crises have a way of waking investors up. Whenever the tide goes out, market participants remember that asset values can go down as well as up and that buying a dollar for 75 cents on the dollar is safer than betting on future growth, leading tend a more risk-conscious approach - or so it has gone in the past.
What has actually happened in this case is that the largest growth stocks in the technology sector have rebounded the highest from their March lows in record time, while results are still uncertain, whereas smaller companies in sectors that have traditionally been the hunting ground for value investors have not seen similar spikes.
The data
The Nasdaq is up 50% from its low for the year and is actually positive on the year. Its largest components have also done extremely well: Microsoft (MSFT, Financial) is up 32%, Apple (AAPL, Financial) is up 38%, Facebook (FB, Financial) is up 42% and Amazon (AMZN, Financial) is currently trading at all-time highs, having grown 43% from the March dip.
By contrast, the Russell 2000, an index tracking publicly traded small-cap companies, has rebounded by only 18%. The S&P 500, probably the most representative U.S. index, is up 27% over the same period. In other words, the companies that were most overvalued by traditional metrics have done better than undervalued businesses.
Of course, it could be argued that the reason why these large tech companies have done so well is the strength of their balance sheets. After all, in times of uncertainty, when so many businesses are suddenly teetering on the verge of bankruptcy, investors might seek the security of a large cash position.
However, if this is the case, then why is Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) - with almost $130 billion in cash - up just 23% over that same period? Conversely, why is a historically unprofitable and cash-strapped company like Tesla (TSLA, Financial) up a whopping 122% from its low for the year? Clearly, there is something other than balance sheet strength that is being prioritized here.
What is happening?
Over the last decade or so, central banks have pumped huge amounts of cheap debt into our financial systems, and the response to the current crisis has been more of the same. I believe that this has been by far the most important factor in the outperformance of growth stocks over that period. If money is cheap, then betting it on growth becomes more attractive than going through the arduous process of finding undervalued companies.
However, I don’t think this means that investors should abandon value strategies. On the contrary, I think that this flood of cheap capital cannot be sustained indefinitely, and that at some point the music will stop. The problem with value investing is that it can take quite a long time to pay off, but waiting is a small price to pay for the comfort of knowing that your savings are well-protected.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Howard Marks: Can the Government 'Simulate' the Economy
- Jim Chanos Is Still Shorting Grubhub
- The Value Investor's Handbook: Share Dilution
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