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Rob Arnott Says It’s Not Too Late to Buy Into the Value Turnaround

“If you missed the value turn last August, value is priced today to once again offer a second bite of the apple,” the Research Affiliates chair said.

It’s not too late to take advantage of the value comeback, according to Rob Arnott, Vitali Kalesnik, and Lillian Wu from Research Affiliates.

While value stocks have consistently underperformed over the past decade, their luck shifted with the rollout of Covid-19 vaccines and the easing up of pandemic-related restrictions. With the onset of the Delta variant, this trend is poised to happen again.

Before the pandemic, value investors struggled as growth equities outpaced value stocks. In fact, the years 2017 to 2019 were the worst years for value investing in its history. From January to August 2020, as Covid-19 spread around the world, investors further abandoned value stocks. According to research from Research Affiliates, the effects of the pandemic compounded value investing’s downturn, resulting in an additional 21 percent of underperformance. 

Arnott and his colleagues attributed the deeper downturn in value investing during the beginning of the pandemic to several factors, including harder hits to the labor- and capital-intensive sectors that value stocks are largely associated with and the fact that companies “tend to have anemic growth and thin profit margins” in unstable global environments. Conversely, growth stocks, which are largely tech companies, were perceived as being resistant to pandemic-related challenges.

“The narrative was that these growth stocks are making it possible to have lockdowns and still for many businesses to continue functioning,” Arnott told Institutional Investor. “These tech stocks were allowing us to shop remotely, communicate remotely, and so forth and so on, and therefore were beautifully positioned for the pandemic and a post-pandemic world.”

That was true, he said. But it didn’t take into account the resilience of value stocks. 

“On the value side, the presumption was that the shutdown would lead to rolling bankruptcies across the economy, and these bankruptcies would primarily afflict the value companies,” Arnott said.

According to Arnott, that narrative ignored the power of the stimulus to prop up value companies and the ability of those companies to weather the pandemic’s storm. In the end, the rolling bankruptcies didn’t happen, and from September 2020 to mid-May 2021, value stocks rebounded.

“Value snapped back big time,” Arnott said.

However, the rebound didn’t last for long. With the emergence of the Delta variant and anxieties about potential macro pressures and lockdowns, tech stocks increased and value stocks’ momentum stopped short.

“The natural question was, ‘Was that it for value stocks?’” Arnott said. “Based on our findings, value companies have not struggled worse than in the past. Growth companies have prospered more than in the past, but not by a wide margin.” 

Arnott and his co-authors speculated that if the Delta variant subsides, investors could be in for another value investing peak. According to previous research included in the paper, this is relatively typical value investing behavior during an economic downturn.

Arnott, Kalesnik, and Wu wrote value strategies rebalance into cheap value stocks at the end of a recession. As the recovery from the downturn continues, the cheap value stocks gain value and reward investors who bought them at their lowest. This happened during the onset of the pandemic, and, according to Research Affiliates, it is happening again with the Delta variant scare. 

“If you missed the value turn last August, value is priced today to once again offer a second bite of the apple and to once again give us a chance to top up value,” Arnott said. “So, you didn’t miss the value turn; you missed the first bounce off of an all-time low.”

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