The tactical case for buying into value today
Awkward truth that it may be for some investment opinion-formers, the idea that value is all about the direction of interest rates or inflation or economic growth does not stand up to any level of scrutiny
Are higher interest rates and economic growth expectations really the only factors to consider when it comes to the performance of a value-oriented investment strategy? Certainly that has been the dominant market narrative of the last decade or so but, here on The Value Perspective, we would be very wary indeed about reading too much into what many market-watchers apparently view as a watertight relationship.
The reason we say that is because history shows the link between value returns and interest rates is – to put it charitably – unstable. To put is uncharitably, the link is pretty much non-existent. As the following chart of US equity market data illustrates, as soon as you analyse a statistically significant sample of historical data, changes in interest rates do not consistently translate into value outperformance or underperformance.
Granted, as you can see in the top left-hand corner, the correlation between the relative performance of the US Value index and 10-year US real yield changes has been positive over the last three years. Over the past five decades, however, the average correlation has been just 0.07 – and it has oscillated all over the place, both positive and negative, in that time. To put it another way, there is no meaningful relationship here.
Awkward truth that it may be for some investment opinion-formers, the idea that value is all about the direction of interest rates or inflation or economic growth does not stand up to any level of scrutiny. In fact, that narrative is really quite a recent stockmarket phenomenon – and not one, we believe, on which longer-term investors should be placing too much emphasis.
Where then should such investors be looking when it comes to the near-term value opportunity? Here on The Value Perspective, our attention is squarely focused on the fundamental valuation discrepancies that currently exist across global equities. Valuation dispersion within the market – that is, the gap in fundamental valuation between the most highly rated and the least highly rated shares – is at extreme levels.
Indeed, as the following chart illustrates, the metaphorical elastic band between the loved and unloved parts of the market remains stretched to an almost unprecedented degree. That is so even when you take into account the not inconsiderable swing in value’s fortunes following last November vaccine announcement by Pfizer, when investors reappraised many of the cheaper areas of the market that were hit hard in the Covid sell-off.
Investors are likely to look back on this period as a very good time to have added to their value exposure. Here on The Value Perspective, we believe that not because we think interest rates are heading in a particular direction or economic growth will surprise to the upside but because today represents a very rare opportunity to buy the value parts of the market when the fundamental valuation discount remains close to all-time highs.
That, at least, is the tactical case for building up your value exposure – and thus, with its focus solely on the short term, is an argument we do not feel totally at ease advancing. Next time, in Value is for life, not just a few quarters, we will move to firmer ground and focus on the long-term case for owning value as a permanent strategic part of any equity allocation.