In a recent blog, I shared some of our asset class positioning to provide insight into how State Street Global Advisors is navigating these conditions. In this post, I want to discuss how we are approaching style investing—particularly value—given persistently slow growth and the underperformance of value this year.
Style investing with a bias toward value
Value investing has struggled as the link between stock performance and fundamentals has weakened. Over the past three years, the Russell 1000® Value Index has underperformed the broader market Russell 1000 Index by 1.3%.1 Overall risk characteristics and monetary policy have been more important than traditional metrics. We’re finding that cautious investors, who have few options for returns besides equities, are willing to pay a premium to buy low-risk, high-quality securities. While that may seem to make sense in the near term, a longer perspective is needed to truly drive returns in portfolios.
Value is a factor that is core to our investment approach across multiple disciplines. Does the recent underperformance mean that value investing is dead? Absolutely not. In an environment where bond yields, GDP forecasts and other leading indicators are signaling low growth and possibly recession across global regions, paying more attention to valuation and investments with more attractive risk/reward characteristics, such as energy, is even more compelling.
Now is a good time to review portfolios to ensure that risk avoidance does not dominate holdings, and that there is the proper amount of exposure to lower valuation stocks, sectors and asset classes as these will be the areas that drive returns going forward.
Value poised to bounce back?
The last time value substantially outpaced growth globally was in 2006, according to MSCI, and after 10 years of lagging results in any style, we would expect an eventual rebound. The chart below shows that valuation spreads are closing in on peak levels not seen since the late 1990s technology bubble and such an extreme spread suggests value may be likely to bounce back.
Source: FactSet, Worldscope, MSCI data, as of 7/29/2016. Difference between sector-neutral ratios for cheap stocks and expensive stocks.
The challenge is that good value often comes in areas that present their own issues. For example, emerging market equities have had a good bounce this year, but continue to be relatively inexpensive compared to developed markets.2 There are definitely shorter-term issues to be considered, but for long-term investors, emerging market equities may be an area that can act as a driver of future performance.
As always, the danger is buying value traps—the wrong inexpensive stocks that will only get cheaper. To avoid this, we pay attention to more than just valuation. We closely monitor balance sheets, particularly in financials, to shield us from companies that may not get through to the next cycle if there is a recession. Other metrics, like earnings growth and price momentum, are ways to further pinpoint good value in the market.
In my next post I'll outline three longer-term themes we are tracking in the search for growth.