In his latest interview on the Excess Returns Podcast, Rob Arnott explains why value is as cheap as it’s ever been, with the two exceptions of last summer and the peak of the tech bubble. Here’s an excerpt from the interview:
The one argument for why value investing has fallen off a cliff is actually a very encouraging one and that is value has underperformed by getting cheaper. Now that sounds like a tautology of course it got cheaper that’s what it underperformed.
No I’m talking about cheaper in valuation relative to growth measured using valuation multiples. So if let’s take the tech bubble as an example, in two years value underperformed growth by 4000 basis points, but its relative valuation relative to growth fell by 50 percent.
So if a stock has fallen by 40 percent and its price to book value has fallen by 50 percent then that must mean its book value is actually rising, or in the case of value factor the value portfolio’s book value is rising faster than the growth portfolio’s book value.
Well if you look at it that way are you gonna say get me out of here I can’t stand the pain? Most people will do that.
Or are you gonna say I can’t believe how cheap this is, it’s unprecedented. If I can possibly persuade my clients to top up they’re going to get rewarded, and reciprocally in 2007 you would say value is as richly priced as small a discount as we’ve seen in the last 30 years, so maybe at this stage I should lighten up on value and go back towards passive would have been a perfectly reasonable answer. But by then everybody was pouring money into value strategies because their past returns were great.
When past relative valuation has been soaring your past returns will look brilliant, and if there’s any mean reversion your future returns will be lousy.
So at the peak of the tech bubble growth stocks were 10 times as expensive using the fama french growth versus value portfolio, 10 times as expensive on price book value as the value portfolio.
By last summer it was 12 and a half times as expensive, an even bigger peak for the FANMAG stocks than the peak for the generation one tech bubble relative to value.
Now we know what the aftermath after 2000 was value beat growth for seven years by cumulatively well over a hundred percentage points, ten thousand basis points.
We’ve seen a snap back of about twenty percent, two thousand basis points for value relative to growth since the early September trough and that’s only tip of the iceberg of chipping away at the magnitude of cheapness that now constitutes value.
So I look at value as being not as cheap as last summer but apart from last summer and the peak of the tech bubble it’s never been cheaper than it is now.
You can watch the full interview here:
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