The Pendulum Will Swing Back to Value Stocks

A recent blog posting over at Morningstar sniped at Professor Jeremy Seigel of Wisdom Tree, indicating that his firm's stock selection methodology and retention of assets depended on his call that a market bottom had been hit.

The post compared the performance of several Wisdom Tree ETFs to various total market benchmarks, showing relative YTD performance is lagging for Wisdom Tree dividend selection process. While true, it ignores the beating that all value benchmarks have taken since the credit crisis began in the summer of 2007.

As most value investors know, they aren't going to beat the benchmark every year - but it's going to happen often enough to outpace growth funds by about 2% annually over the long haul.

What's been unusual about this bear market is that it's the so-called value stocks leading the slump, whereas value stocks almost always outperform in weak markets.

Obviously, in this case, that's because the fact is that so many stocks that are usually labelled as value stocks, due to either low PE ratios, or relatively high dividend yields, have found themselves trashed and tarnished by the credit problems. That's because financial firms (whether retail or investment banks, stockbrokers and insurers), which usually have relatively low PE ratios and relatively high dividend yields - putting them squarely in the value camp - have been the epicenter of the credit and economic problems. Wisdom Tree's dividend selection process obviously weights orients a portfolio towards a value selection.

Comparing other value ETFs against growth ETFs show that this phenomenon isn't restricted to Wisdom Tree selections.

For instance, since just before the credit crisis began (I am using June 1 2007 as the date), the Barclays iShares products tracking growth or value indices show the following divergences:

- For international stocks, the MSCI EAFE (Europe, Australia, Far East)iShares index-tracking products shows that the growth product (EFG) has lost -13.2% of its value, compared to much larger -25.3% loss for the value product (EFV). In that context, Wisdom Tree's International Dividend Top 100 EFT (DOO) loss of -16.6% is pretty good.

- For large cap domestic stocks, the iShares growth product (IVW) has lost just -9.0%, while the value product (IVE) has lost -20.8% of it's value. Again, in that context, the Wisdom Tree Large Cap Domestic ETF (DLN) loss of -19.8% is understandable.

- Finally, for domestic small cap, the iShares growth product (IWO) lost 6.5%, while the value ETF (IWN) lost -17.2%. Here, the Wisdom Tree loss is larger at -23.2%.

Given that growth rarely outperforms value for any stretch of time, I believe that the relative outperformance of value must be just around the corner.

In summary, I'd suggest to all value investors in general, and Wisdom Tree ETF holders in particular, to hang on. Retail investors are notorious for dumping underperforming funds, not long before the corner is turned. Don't be one of those fools.

Comments

[ETF Wanderer:]

i have been tracking the value-growth spread as a part of my regular work. this month should have been really good for value out-performance, with the bounce back in financials etc.

however, if you take a look at the charts of the value-growth spreads (e.g. avg earnings yield of top decile minus bottom decile), they have broken long term trend lines and appear quite negative to say.

any correction or reversal in value-growth characteristics of any stock can happen by either the price or the value measure. for instance, suppose we use earnings/price as a measure, then a stock can change from value to growth by either change in the earnings or change in the price term - and a change in the price is what is commonly called as "value trap" - more specially a lot of companies which are value companies only because their declared earnings haven't kept inline with their prices. the level of companies in possible "value trap"s are also quite extremely high at present (i am assuming that you are well versed with all these).

i agree value should outperform growth in the long run, but currently the level of value traps and the break in the trends indicate otherwise and the bounce-back in financials is good, but we will have to wait and see if it is not a dead-cat bounce (as someone else on this blog has put it).

2008 Aug 12 10:00 AM

[RobinAllenson:]

"Given that growth rarely outperforms value for any stretch of time, I believe that the relative outperformance of value must be just around the corner" -- it ain't necessarily so. There have been a number of 3, 5 and much longer stretches where growth has beaten value, but just not in the last while. The key questions remain: when and why do value beat growth and why? I expect growth to be the right bet for some time yet.

2008 Aug 12 10:43 AM

[WEBISKING:]

value stocks like beauty is in the eye of the beholder. Anyone who buys a bank is probbaly not a value investor unless their last name is Buffett. Understanding the investments the banks have made in thepast years is nea impossible for all but a couple like WEB.

2008 Aug 13 09:24 AM