Value

While the momentum factor often sees sizeable performance swings, in February, growth was the outlier with a -9% spread—the worst since September 2008. Growth has become very correlated with beta, making it more susceptible to underperformance during a flight to safety.

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Value’s migration behavior was the key to its failure between 2010-2020—its pattern got progressively worse, culminating in a Value trap during 2017-2020. We believe macro tailwinds and positive surprises are both needed, and, while the setup on the macro front, post-2020, has become quite favorable, in order to breathe more life into Value we need to see the upswing in earnings surprises continue.

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Value has worked much better within small caps compared to large caps for three of the last four years. This is nothing new, though, as value is historically a much better factor within the less efficient smaller-cap universe.

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Growth has performed much better among large caps than small caps, resulting in higher relative valuations for large caps. Based on factor valuations, we think value provides a more attractive large-cap entry point, while growth looks more attractive within small caps. 

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Both Growth and Value Small-Cap style boxes gained 10% in January’s rally. However, SC Growth remains well in the rearview mirror since its relative strength peak in September 2020: Small Cap Growth +8% versus Small Cap Value +60%.

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Deflating valuations in the Technology and Innovation space produced ghastly results for growth investors in 2022, with the S&P 500 Growth index experiencing an agonizing 29.4% loss. Meanwhile, last year’s bear market was no more than a mild irritation for value investors as the S&P 500 Value index lost just 5.2%. The collapse in exuberantly priced growth stocks produced a 24.2% return spread between the value and growth styles, which goes into the record books as the second biggest annual win for value since 1975.

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Style rotation powered S&P 500 Value to a 24.2% advantage vs. Growth, while DM large-cap Value earned a 20% return spread against Growth. Small-cap spreads favoring Value were also in the double-digits, but narrower because small-cap Growth wasn’t exposed to the collapse of mega-cap Tech. 

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Equity factors are characteristics that have historically generated excess returns relative to the universe of stocks. However, in recent years factor returns have been underwhelming, causing investors to wonder if factors have become too popular, too crowded, or just plain obsolete. Then came the second quarter of 2022, when all six major factors outperformed the S&P 500, a feat only accomplished in four quarters over the last 27 years!

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From the end of 2020 through May, stocks in the top quintile of both value and momentum have returned 60% versus 7% for the overall universe. That compares to the brutal stretch from 2016-2020 when the only way momentum investing worked was to not only disregard valuations, but to actively buy the most expensive momentum stocks.

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It is a scene easy to imagine: Two children on the playground arguing about who’s the top dog. This schoolyard scuffle played out in 2021 between the Value and Growth styles, with each claiming bragging rights from their own perspective.

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For our more fundamentally-oriented readers who are repulsed by all this talk of momentum, we have an alternative. Just forget about performance and focus solely on value!

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Quant researchers widely agree that Value offers a return premium over time (although not recently) and that High Quality also offers excess returns. The Quality angle seems contrary to intuition, in that investors generally prefer Quality companies and are willing to pay up for them, yet Quality regularly outperforms. Value and Quality are both well-respected investment factors, and we were curious to explore the interaction of these two smart beta stalwarts. Is Value enhanced by adding a layer of Quality, thereby avoiding value traps, or are Value investors better off buying junky, unattractive companies that have the most room to rebound from depressed prices?

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The weakness in Value* over the last few months has gotten a lot of attention (Chart 1). While we are still on board with the “Value trade” in general, a subtle but distinct change within the theme has emerged. There is a clear bid for Quality, which had not happened in the massive post-Covid junk rally until recently.

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After years of underperformance, investors who pay attention to both Momentum and Value are finally being rewarded. The turnaround has been substantial, but the relative valuation of expensive Momentum vs. cheap Momentum stocks is still extremely elevated by historical standards.

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Our ongoing research into the relative performance of active vs. passive styles reveals that market conditions play a significant role in the active/passive return cycle. We identified a set of metrics that describe the market conditions we believe influence which management style is more likely to outperform. This note updates our data through March 2021.

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While Value outperformance continued throughout the first quarter, March saw higher-quality Value names take the lead. Prior to March, it was mostly the unprofitable companies that had driven the rotation.

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Investors looking for the long-awaited rebound in the Value style point to the potential for rising interest rates as a possible driver of style rotation. Higher rates would benefit many Financial companies, a sector closely linked to the Value style. In fact, many commentators believe that the Value style cannot experience a major run without the participation of Financials. We launched a research effort to examine the link between Financials and Value, seeking to understand whether there is truth in this old saw, or whether this connection is more properly classified as market folklore.

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Investors looking for the long-awaited rebound in the Value style point to the potential for rising interest rates as a possible driver of style rotation. Higher rates would benefit many Financial companies—a sector closely linked to the Value style. In fact, numerous commentators believe that Value cannot experience a major run without the participation of Financials.

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With the Bridesmaid approach we’re attempting to capture “stealthy momentum,” rather than pure momentum. Fundamentalists—and especially value investors—might find that to be a distinction without a difference. 

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Driven by massive government stimulus, an imminent vaccine rollout, and the expectation of record earnings in 2021, investors seem to be on the verge of embracing a move away from Large Cap Growth stocks in earnest. The leading candidates offered as broad-based alternatives to Large Growth (LG) include Value, Small Caps, and Emerging Markets.

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