Markets

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

Value investing has been in the doghouse for a decade. That’s right, growth stocks have trounced value stocks for a DECADE.

Some investors are betting that it’s finally value’s time to shine. According to Bloomberg data, investors poured $5.5 billion into value ETFs and withdrew $6.2 billion from growth ETFs so far this year.

Part of value investors’ newfound enthusiasm springs from classic folklore – the old adage that value stocks outperform during expansions and languish during contractions. If the Fed’s insistence on raising rates is a signal that the U.S. economy is picking up steam, then it’s a new day for value stocks, right?

Not so fast. Let’s start with the obvious if inconvenient fact that the last several years have bucked the conventional wisdom. According to the National Bureau of Economic Research, the U.S. economy has expanded since July 2009, yet growth has beaten value since then. And if value investors look further back, they'll find many more exceptions to the old saws about growth and value.

The notion that value stocks should thrive during expansions and wilt during contractions is intuitively appealing. A company’s stock is oftentimes demoted to “value” because its business is struggling – sales might be slow or management might be failing to contain expenses or the company might be under a mountain of debt or the whole industry might be in a funk (for a present day example of the latter, see financials and energy).

A booming economy is a magical antidote for many of those problems, but an economic downturn can be a death sentence.

At first glance, the data appears to support this theory. I compared the returns of the Fama/French U.S. Large Value Research Index to those of the Fama/French U.S. Large Growth Research Index during expansions and contractions, as recorded by NBER, going back to inception of the indexes in 1926. The Value Index returned an average of negative 1 percent during contractions while the Growth Index returned an average of 1 percent (those are cumulative returns through March 2016, including dividends). It was just the opposite during expansions – the Value Index returned an average of 135 percent, while the Growth Index returned an average of 95 percent.

Look deeper, however, and the theory starts to fall apart. There have been 30 alternating periods of expansions and contractions since 1926. In seven of those, value didn’t behave as expected – value beat growth during five contractions and trailed growth during two expansions (including the current expansion).

Not so Fast
Value's behavior defies simple rules, besting growth on average during both bull and bear markets since 1926.
SOURCE: Fama/French
Methodology: Cumulative total returns from July 1926 to March 2016; bear market is a 20-plus percent decline in the S&P 500’s total return.

And it gets worse. Market cycles don’t neatly align with business cycles, of course, and the picture becomes even more blurry when looking at value’s behavior through the lens of market cycles.

I identified 23 bull and bear markets in the U.S. since 1926, using a 20-plus percent decline in the S&P 500’s total return to define a bear market. As you would expect, the Value Index bested the Growth Index during the bull markets, with an average cumulative return of 370 percent for the Value Index versus 286 percent for the Growth Index. But surprisingly, the Value Index also beat the Growth Index during the bear markets, with an average cumulative return of negative 31 percent for the Value Index versus a negative 36 percent for the Growth Index.

Also, value behaved as expected in just 12 of those 23 bull and bear markets – or just barely over 50 percent of the time – and there were many notable (and in some cases surprising) outliers.

For example, value trailed growth during three of the most iconic bull markets – the latter half of the roaring 1920s, the Nifty Fifty craze of the early 1970s, and of course the internet mania of the 1990s. And value managed to beat growth during bear markets whose mere mention still makes investors queasy – the 1973-74 oil embargo that sent stocks tumbling and the infamous crash of 1987.    

So much for conventional wisdom.

Great Expectations
Value has bucked conventional wisdom by trailing growth during the current expansion that began in 2009.
SOURCE: Fama/French

There does appear to be one reliable takeaway, however. When things get ugly – and I mean epic-everyone-fears-the-end-of-the-world ugly – value stocks are almost assuredly the wrong place to be. They were hammered during the Great Depression and again recently during the Great Recession. Investors who expect another monster storm (and fancy themselves gifted with precognition) should probably stay away from value stocks.

Value is a timeless investing style for those with the patience to hang on. But value stocks never have and never will dance to the rhythm of business or market cycles.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nir Kaissar in New York at nkaissar1@bloomberg.net

To contact the editor responsible for this story:
Timothy L. O'Brien at tobrien46@bloomberg.net