In their recent article titled – DEEP VALUE A Rose by Any Other Name Would Smell as Sweet, GMO explain why deep value stocks present compelling opportunities as they are trading extremely cheaply compared to broad markets and their historical averages.
Outside the U.S., deep value is at the 2nd percentile of its history, while in the U.S., it sits at the 10th percentile. Mean reversion of valuation gaps is expected to drive strong returns, especially outside the U.S., where value is starting to outperform.
In contrast, U.S. growth stocks, fueled by AI and megacap dominance, remain overvalued. This highlights the importance of diversification, with international equities offering better medium-term returns than their U.S. counterparts.
Here’s an excerpt from the article:
In a world with some markets sitting at or near all-time highs with elevated valuations, deep value offers compelling opportunities across regions. Deep value stocks are trading extremely cheaply relative to broad markets and their own history. In an expensive world, this combination leaves them positioned to deliver strong absolute and relative returns.
Outside of the U.S., all value is cheap, but deep value is in the 2nd percentile of its history. Within the U.S., deep value is similarly sitting at the 10th percentile of its history, while the rest of value should largely be ignorable at current valuations.
History shows that these valuation gaps shift through time, and mean reversion of spreads is a reliable and rewarding way to invest. Over the last year or so, it appears as if value is starting to outperform outside of the U.S.
Meanwhile, the AI revolution and the dominance of megacap may have temporarily postponed the turn in the U.S., although July registered the first significant relative step back for growth.
We estimate that a full reversion to median historic relative valuations would need value to outperform growth by roughly 60%. Even absent mean reversion, at current valuations, value is positioned to handily outperform.
As an aside, it is important to note that the investor exuberance that has fueled growth stocks in the U.S. has also done a tremendous job of driving valuations across the wider U.S. market (with the exception of deep value) to precarious levels.
It is for this reason that our Asset Allocation strategies favor equities outside the U.S. in expectation of markedly higher medium-term returns.
Some investors may expect the dominance of U.S. growth to continue, but is it really necessary to take that position? The shifting dynamics across styles and geographies argue that now could be an excellent time to introduce some diversification.
You can find the entire article here:
DEEP VALUE A Rose by Any Other Name Would Smell as Sweet
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