Forced Selling Prolongs Underperforming Value Investing

by: Larry MacDonald

Hedge fund manager Goodwood Inc., an activist value investor, confirms forced selling in the stock market. “We believe there has been a significant amount of selling recently in some of our core names by other institutions that have been experiencing redemptions,” they note in their latest Monthly Commentary.

The forced selling is prolonging the underperformance of the value investing approach — which has been quite extensive lately. Research published on the U.S. market by Joseph Mezrich, head of quantitative research at Nomura Securities, shows a model portfolio of momentum stocks gained more than 70% year-over-year while a model portfolio of value stocks fell about 50%. Value stocks haven’t been this cheap in 35 years.

Historically, when value stocks get beaten up to this extent, they usually go on to do very well. However, this time round, they are cheap mainly because of the financial sector, which is facing historic problems. Some say the business models in the financial sector are busted, just like dot-com business models were busted in the early 2000s.

On the other hand, some would say monetary policy in the U.S. is based on central banks feeding the commercial and investment banks enough liquidity to keep them lending and dealing liberally. So the business models of the financial institutions will survive and flourish because they are a necessary adjunct of the central banks’ modus operandi for managing economic fluctuations.