B of A Securities quantitative strategist Savita Subramanian published a compelling, seven point argument this week advising clients to allocate at least a small portion of their equity portfolios to value stocks.
The strategist began by noting the success of valuation-conscious investing over the extreme long term. One dollar invested in U.S. value stocks in 1926 would be worth US$13,447 now, more than double the $6,267 that growth stocks would have generated.
The performance of value stocks during economic and profit recoveries is a key reason for optimism. Historically, value stocks have outperformed the overall market immediately after bottoms in economic growth and earnings growth. B of A believes the economic trough is just behind us, and that second quarter profit results will mark the bottom in U.S earnings.
Value stocks are also neglected in the current market. Ms. Subramanian observed huge asset inflows into growth stocks while portfolio managers are broadly underweight companies with lower price to earnings and price to book value valuations. This lack of faith in attractively valued stocks implies outperformance in the coming years.
Value stocks are also extremely cheap relative to the rest of the S&P 500. “Value stocks trade at record levels of cheapness to momentum stocks,” the strategist writes, while “growth [stocks] by almost any measure trade at record [high] premiums to the market.”
Ms. Subramanian goes on to highlight the dominance of large cap growth stocks in the index, and suggests that we’re nearing the point where government anti-trust regulation will force break-ups or otherwise limit their influence. This is almost certainly a reference to technology companies like Amazon.com, Alphabet Inc. and Facebook Inc.
The average investor prefers to buy assets that are already outperforming – the investments that have the highest returns over the past 12 months tend to attract the most new assets. They will be resistant to value-oriented stocks or ETFs then because they have badly lagged the major equity benchmarks since 2007.
But Richard Bernstein, founder of asset management firm RB Advisors and a former mentor of Ms. Subramanian’s when he was chief quantitative strategist at Merrill Lynch, cites “returns are best where capital is scarce’ as one of his primary rules of investing. Value stocks are currently neglected and starved for capital, and this provides yet another reason for investors to consider a value stock component in their portfolio.
-- Scott Barlow, Globe and Mail market strategist
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