Abandoning Value Stocks Requires Some Dubious Assumptions

One of the most popular and reliable touchstones of investment strategy is value. Buying stocks with lots of current good things — book value, earnings, dividends — per dollar spent does better in the long run than buying stocks with hoped-for future good things. This principle seems to apply to other assets as well.

But this is a long-term claim measured over large portfolios tracked over many decades. Value goes through extended periods of underperformance, often when markets are frothy and investors are pouring even more money into the most overvalued assets. The 2010s were not kind to value, especially from 2017 to 2020, but the 2020s are making up for the losses rapidly.

A popular explanation for the trends is that value is an interest rate bet. The story goes that value stocks deliver cash flows in the immediate future, while growth stocks promise cash flows farther in the future.1 At high rates, the present value of future cash flows is diminished relative to current cash flows, so value stocks are attractive relative to growth. But when rates are low, value is less attractive. The underperformance of value occurred at a time of low rates, and value revived when rates started to climb.