Why Value (Still)
Markets & EconomyADVISOR QUESTION OF THE WEEK: After a historically poor period for the value premium and a negative premium YTD, why should we still believe in value?
Some investors may have anticipated a big year for the value premium in 2023 given the historic weak stretch from July 2017 to June 2020 and subsequent bounce-back leading up through the end of 2022.
However, US value stocks have underperformed their growth stock counterparts in 2023, primarily in the large cap area of the market (see Exhibit 1).
Exhibit 1: Equity Market Overview
All Country Markets Returns (USD), Year to Date as of September 30, 2023
Past performance is no guarantee of future results.
Market returns are computed from MSCI All Country World IMI Index published security weights, Dimensional computed security returns, and Dimensional classification of securities based on size, value, and profitability parameters. Within the US, Large Cap is defined as approximately the largest 90% of market capitalization in each country or region; Small Cap is approximately the smallest 10%. Within the non-US developed markets, Large Cap is defined as approximately the largest 87.5% of market capitalization in each country or region; Small Cap is approximately the smallest 12.5%. Within emerging markets, Large Cap is defined as approximately the largest 85% of market capitalization in each country or region; Small Cap is approximately the smallest 15%. Designations between value and growth are based on price-to-book ratios. Value is defined as the 50% of market cap with the lowest price-to-book ratios by size category and growth is the highest 50%. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. High profitability is defined as the 50% of market cap with the highest profitability by size category and low profitability is the lowest 50%. REITs and utilities, identified by GICS code, and stocks without size, relative price, or profitability metrics are excluded from this analysis. GICS was developed by and is the exclusive property of MSCI and S&P Dow Jones Indices LLC, a division of S&P Global. Countries not in the Dimensional investable universe are excluded from the analysis. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. MSCI data © MSCI 2023, all rights reserved.
While recent returns may be disappointing, the first half of 2023 marks only the 10th time since 1926 that value stocks have underperformed growth stocks by more than 20 percentage points over a two-quarter period.
More often than not in these instances, value has responded by beating growth over the following four quarters while averaging a cumulative outperformance of nearly 29 percentage points (see teal bars in Exhibit 2).
Exhibit 2: When Value Delivers
Cumulative return difference for value minus growth in US stocks over the four quarters following two-quarter periods during which value underperformed by –20% or outperformed by +20%
Past performance is no guarantee of future results.
In USD. July 1926–June 2023. Quarterly returns for value and growth based on the Fama/French US Value Research Index and the Fama/French US Growth Research Index, respectively. Data provided by Fama/French. The Fama/French indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. See “Index Descriptions” for descriptions of the Fama/French index data.
Looking at the other side of the value performance distribution in green above, there have been nearly twice as many (19) two-quarter periods with the value premium exceeding +20%. In 11 of these, value outperformance continued over the next four quarters.
Diversifying globally can also help improve the reliability of capturing premiums, as they do not move in lock-step across countries. This year the value premium has been negative in the US—but strongly positive in other markets, with 31 countries recording a positive value premium in large caps.
Regardless of value’s recent performance, investors should expect positive value premiums going forward because a lower relative price is associated with higher expected returns over the long-term. While we don’t believe there is a reliable way to predict when positive premiums will occur, they tend to materialize quickly and in large magnitudes when they do.
Thus, to effectively capture the value premium, we strongly believe it is essential to remain disciplined and diversified and to avoid trying to time the markets.