John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.
It's certainly been one long decade for value investors. This year had promised to see a reversal of years of underperformance, but at least so far, that hasn't happened.
Is there still hope that conditions may finally be turning?
Yes, this has been said before only to be proved wrong. Many expected the turn to come in 2015 and again in 2016, and for a while, it appeared it might have finally done so. But the market roared last year on the expectation of lower regulation and tax cuts, negating any momentum value might have gained.
Since the end of the financial crisis, growth stocks have crushed value names. Last year's dominant showing by the biggest tech companies and the strong start to this year by large-cap and growth stocks are just the most recent proof.
The argument for the return to value is rational. Value stocks do well when the economy is revving up and interest rates are rising. Both of these conditions are truer now than they were even at the start of last year's 20-per-cent market gain.
The last time value stocks were king was during the early and mid-2000s. Of course, that was coming off the bursting of the dot-com bubble of the late 1990s and the bull market that started in late early 2003 was very rewarding for the value stock category.
But the long drought for value investors in recent years has led even savvy professionals to question whether the strategy even works. David Einhorn, a hedge fund manager who became a billionaire over his career by going long undervalued stocks and shorting overvalued stocks, asked that question last year, after sustaining losing bets against Tesla and Amazon.com.
"The knee-jerk instinct is to respond that when a proven strategy is so exceedingly out of favour that its viability is in question, the cycle must be about to turn around," he wrote in a letter to shareholders in October. "Unfortunately, we lack such clarity."
A look at the track record of some of the most famous value investors over a period of time far longer than seven, 10 or even 15 years, and you start to see another picture. Warren Buffett's Berkshire Hathaway rose 19 per cent annually over 52 years through 2016, for example. The S&P's average return was 11.2 per cent.
Interest rates may prove to be the final inflection point for value. The U.S. Federal Reserve has signalled several rate increases to come as it moves away from its easy policies meant to get the economy up and running after the financial crisis. The U.S. economy is already growing near 3 per cent. If it threatens to overheat, the Fed may have to step in more than it expects.
Again, during periods of rising interest rates, value stocks outshine growth stocks.
Why is that? The future cash flow of high growth companies gets hurt by rising interest rates. When rates increase, it makes these companies' future cash flows worth less in today's dollars when discounted back to the present value (the inverse is true with falling rates). That makes value stocks, which are valued on profits that are more predictable and consistent, look relatively favourable.
It's been difficult for value investors to stick to their strategy and not be tempted to jump ship, but they may soon be rewarded. At Validea, we have designed portfolios that take the guesswork and emotion out of investing by using fundamental analysis to pick stocks based on how they track various guru-inspired models.
Using the Value Investor model, which is based on the approach outlined by Ben Graham in The Intelligent Investor, I've highlighted eight deep value stocks. Keep in mind that value stocks are trading at low valuations because many of them have problems or risks, and there are dark clouds hanging over their businesses. However, investors looking for discounted names may consider some of these as potential value opportunities.