I’ve often posted blogs about the perils of trying to time the market or pick individual stocks. I hope these posts have helped you stay invested as planned during this year’s uncertainties. But what about the risk factors in your stock portfolio: especially the value factor?  Should you try to time these?  Or are you also maintaining a disciplined allocation to them, also according to plan?

Value-added, with a catch

First, what is the value factor? Value stocks seem undervalued compared to their growth stock counterparts, as measured by stock price vs. various valuation metrics (such as book value, earnings, or cash flow). Historically, investors who have held a heavier allocation to value stocks have earned higher returns, beyond what broad markets have delivered.

But to capture the value premium over time, investors have had to tolerate the sometimes-lengthy periods when value underperformed growth. 

The catch is, value investors have had a tough go of it during the past decade and in particular the past 3 years.  Although very short-term, some are wondering if the tide is starting to turn,  given some moderate value outperformance in the US and some significant value outperformance in Canada and non-US markets since mid-April.  Even so, the long stretch of underperformance has led some investors to question whether the value premium still exists.

Value glasses, empty and full

Without diving too deep, there are two broad ways we can view the value premium today. A “glass half empty” analysis might conclude a decade-plus pattern of underperformance means it’s gone for good. However, a “glass half full” type knows there is plenty of logic and evidence to suggest that rumors of the value premium’s demise are probably premature.

Still as risky as ever:

Ever since Nobel laureate William Sharpe came up with the capital asset pricing model in the 1960s, it’s been pretty clear that investors demand extra compensation for taking on extra investment risks. As risky as value stocks have felt lately, it’s certainly still logical to expect them to eventually pay off in higher returns.

Like a swinging pendulum:

Put another way, will returns that have swung to one extreme eventually revert or swing closer to their long-term averages?   As Dimensional Fund Advisors describes, “It’s reasonable to expect that securities with lower prices relative to fundamentals should have higher expected returns.” In other words, the riskier (lower-priced) value stocks become relative to growth stocks, the more (not less) likely a correction will eventually occur.

The bigger they are:

Some say huge tech stocks have now become the best source of expected return.   Continue Reading…