Value: If Not Now, When?

Executive Summary

After more than a decade of disappointing performance, Value stocks just experienced their worst 12-month performance in history. This has left these stocks trading at some of the cheapest levels relative to the market we have ever seen. This cheapness is robust to a variety of challenges that skeptics may raise, and this is true broadly across all major equity regions. An analysis of the sources of returns for Value since 2007 shows that more than 100% of Value’s underperformance is due to falling relative valuations, confirming that under the surface the Value premium actually still exists. If Value were to continue trading at current spreads to the market and experienced the same relative fundamental performance as it has over the past 14 years, it would beat the market. The flip side of the extraordinary cheapness of Value is the expensiveness of Growth: we believe Growth stocks have entered a bubble similar to the one in 2000. While we are not sure what the catalyst will be for the deflation of the Growth bubble and the recovery for Value, there are a number of plausible candidates for one, not least the eventual recovery of the global economy over the next 12-18 months as the pandemic recedes. We believe the outlook for Value is exceedingly bright from here, particularly in a long/short framework, which can profit from Value’s outperformance in both rising and falling markets.

How To Profit From A Growth Bubble
By Ben Inker

Executive Summary

The current Value opportunity is reminiscent to us of previous bubbles in global markets. In several of these we built long/short portfolios for our clients and were able to capture strong returns for them as mean reversion occurred. Earlier this fall, we launched a new one, the GMO Equity Dislocation Strategy. This strategy is long undervalued stocks and short overvalued stocks globally, and we believe it has the potential to achieve the 80+% cumulative net returns we captured for clients invested in the GMO U.S. Aggressive Long/Short Strategy during the bursting of the TMT bubble. While the portfolio is certainly long Value and short Growth, it does not look much like style indices or ETFs, which we believe have excessively large sector biases and too much stock-specific risk. We are using Equity Dislocation in the multi-asset and liquid alternatives portfolios the GMO Asset Allocation team manages. For investors who are still believers in Value, we think this strategy can be a good complement to long-only Value implementations. And even for those who no longer believe in Value for the long run, we think it would still make sense to contemplate this strategy as a hedge against the risk of cyclically poorer returns to growth-oriented public and private equity portfolios after their decade of extraordinarily good returns.

By Ben Inker and John Pease

It is often hard to take your mind off discomfort. The drumbeat of worry can be made louder, though, if your attempt at mental respite involves – as did mine – reading a book called Migraine.1 No matter how lyrically pain is evoked, or how well-crafted its description, it (unsurprisingly) still reminds the reader of pain. And the year is 2020. And we are Value investors.


As of 9/30/2020 | Source: GMO, Bloomberg, MSCI
U.S. Value defined as the cheap half on market cap within the U.S., including financials.

The performance of Value from 2007 to 2019 was, to put it mildly, uninspiring. This was not altogether surprising, considering the run-up that Value had prior to that period. We at GMO did warn of the peril of investing in cheap stocks at a time when their valuations relative to the broad market looked to be at a record high.2 But the mind-numbing pain of holding Value anywhere in the world over the last 12 months has been something else entirely – it has shattered the record losses of the factor over any year-long period, tech bubble included. It is time, then, to repeat our message from last year, though this time more forcefully: no matter where you look, no matter how you slice it, Value looks cheap (see Exhibit 2).


As of 9/30/2020 | Source: GMO, Worldscope, Compustat, MSCI
U.S. Value defined as the cheap half on market cap within the U.S., including financials.

Value’s Broad Attractiveness

After a very difficult 2020, U.S. Value – as GMO defines it – now trades at the fourth percentile of relative valuation on the blend of metrics that we generally use to evaluate the group’s attractiveness.3 You might object that this is a non-standard definition of Value, and if cheap stocks were chosen using some other metric they might look less interesting. To address this concern, we can analyze how attractive the cheapest half of the U.S. looks when built on 11 different metrics, including GMO’s proprietary “P/Scale” (see Exhibit 3).


As of 9/30/2020 | Source: GMO, Worldscope, Compustat, MSCI
U.S. Value defined as the cheap half on market cap within the U.S., including financials (except for EV-based metrics).