Value Investing

Posted By Darren Winters on Jul 21, 2020


Value Investing

Has value investing died in this new normal as the fundamentals meltdown and risk asset prices melt-up where all that counts is the central bank’s willingness to keep stocks propped up with massive amounts of liquidity.

Not even a deep earnings recession, a coronavirus-induced collapse in profits where earnings have been tipped to fall by 60% in the quarter has dampened the recent bull run in stocks.

So the financially engineered V-shaped recovery is playing out, albeit in stocks with the Dow clocking its best quarter since 1987 as investors/traders chase momentum, it is as if value investing has become irrelevant.

Chasing momentum eventually fails to yield profits, at some point the music stops, the bubble pops and there is a pivot to value investing

Value Investing

The 1999 Dotcom mania in internet stocks is a classic example where investors rejected value investing and instead preferred to chase momentum. 

The Dotcom boom created a stock market bubble caused by excessive speculation in internet-related companies in the late 1990s stocks. Profit is for wimps was the mantra during the Dotcom mania as investors piled into loss-making internet companies, with little or no revenue, in the hope that they would one day be global internet players. Sure, Amazon conquered the retail market but there were countless losers too.

The size of the Dotcom bubble, a period between 1995 and 2000, was historic the Nasdaq Composite stock market index rose 400%, the price-earnings ratio reaches 200, which dwarfed the peak price-earnings ratio of 80 for the Japanese Nikkei 225 during the Japanese asset price bubble of 1991. 

But when reality sets in investors realised that despite the sleek business plan and promise to conquer global markets many of the dotcom companies would never turn a profit, and the famous Dotcom bubble burst into 2000 with a pivot to value investing. So the Dotcom dream emerged as a nightmare for many momentum chasing investors.

Chasing momentum rather than value investing also played out in the real estate market

During the property boom, before the 2008 financial crisis in subprime mortgages, the best game in town was buying a property often heavily mortgaged and flipping it.

Everyone, including the banks and mortgage bond investors, were convinced that residential real estate property values could only keep going up. House hunters including speculative investors were willing to pay any price believing that they could sell anytime higher. 

So the real-estate bubble attracted speculative money into residential real estate, which sent house prices spiraling.

But as liquidity dried up, housing prices tumbled, more people sold, and the real estate bubble burst. The financial crisis of 2007–2008 was related to the bursting of real estate bubble that had begun in various countries during the 2000s. 

In the Dotcom mania and the housing bubble momentum investors, particularly those late in the game were prone to making big losses when the bubble bursts

In short, I am skeptical when I read or hear reports that value investing, the cornerstone of investing is dead. Eventually, there is always a pivot to value investing.

In late 1999, it was stated that “investing like Warren Buffett was the same as driving ‘Dad’s ole’ Pontiac.” The implication here being that value investing was obsolete, and no longer a viable investment strategy and that all that mattered was growth. 

But the Dotcom bubble burst proved the above to be wrong. 

Research Affiliates noted that the media has a long history of declaring sectors, markets, or strategies “dead” based on past performance. 

For example, in August 1979 Business Week declared the “death of equities” and most recently July 2019 the Financial Times questioned whether emerging market investments made sense any more. But both views would have wrong-footed investors. 

So when commentators, the media today talk about the death of value investing it would be prudent to be skeptical.

Yes, it is true to say that with central banks in cahoots with pursuing a policy of staggering global stimulus, a risk-recovery rally is in play.

The main factor in the equation of the Dow clocking its best quarter since 1987 is the central-banks-in-cahoots with pumping over $18 trillion in global stimulus in 2020, which amounts to 21 percent of global GDP. A boom in central bank liquidity is keeping multiple asset bubbles inflated.

Front loading the central banks’ asset purchases, known as quantitative easing QE is creating a bubble many times larger than the dotcom and real-estate bubble.

Exhibit one shows the G6 central banks in cahoots with expanding their already ballooning balance sheet as a percentage of GDP. Notice how 2020 projections show a continuing policy of balance sheet expansion. Source BofA Global Research

So the 2020 stock bull market bubble is being driven by an unprecedented amount of central bank liquidity with momentum investors jumping on the bandwagon.

The great pivot to value investing could be underway, albeit gradually with the rise in the price of risk-off assets

Value investing is already driving up the price of precious metals, the stock price of utilities, and companies that provide non-discretionary services and goods. 

I notice a parallel today with the stock market and the early 2000 real-estate property boom where investors are chasing assets, bidding them higher at any price. 

So an unprecedented amount of central bank liquidity could be the driving force behind the multiple bubbles in stocks, bonds, the real estate of 2020. 

If so, value investing will ultimately win again, as it did during the Dotcom and real estate bubble. Perhaps yet again momentum investors could end up nursing some heavy losses as the multiple 2020 asset bubble bursts. 

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