1. Using quarterly returns data over five-year rolling periods from September 1984 to September 2019, where available, we find that value stocks outperform growth stocks in 284 of 510 rolling outcomes, or 56% of the time, across five geographic regions: US, developed, developed ex US, global, and emerging markets. In the US market, value and growth stocks are represented by the Russell 1000 Value and Russell 1000 Growth indices. For developed, developed ex US, global, and emerging market (EM) stocks, the value and growth indices are represented by applicable MSCI value and growth indices. Our analysis begins in September 1984 for US, developed, and developed ex US stocks, and in September 1996 for global and EM stocks.
2. Brightman, Masturzo, and Treussard (2014) explained the three core investment beliefs that support Research Affiliates’ investment philosophy: 1) investor preferences are broader than risk and return, 2) prices vary around fair value, and 3) lack of conviction restricts investors from exploiting long-term value.
3. Arnott, Cornell, and Shepherd (2018, 2019) discussed how to identify a bubble (and an anti-bubble) in real-time instead of years after the fact. In addition, Baz et al. (forthcoming) of PIMCO make the critical observation that a bubble requires a high probability of continuing into the next period for its existence in the present moment. This high probability of a small movement in the prevailing direction is better aligned with the investment horizon of most investors, even when it is counteracted by a smaller probability of a larger correction, setting the stage for the bubble to eventually burst.
4. We have often suggested that if a half-century ago finance theory had embraced the concept of a “fear premium” instead of a risk premium, many of the anomalies, puzzles, and paradoxes in finance would have been expected, even predicted, rather than coming as a surprise in search of a risk-based explanation. Investors fear unloved deep-value stocks and fear missing out on the trendiest growth stocks. The former should have a higher risk premium, while the latter should have a smaller risk premium, if any at all—hence, the value effect. Investors may typically fear small, unknown companies, while not fearing large, well-known companies they encounter in their daily lives— hence, the size effect. Investors may fear a stock in free fall, but not one that’s rising like a rocket—hence, the momentum effect. And the list goes on. These effects can be arbitraged away, but only if enough investors choose to embrace assets that would normally engender fear. Fear-based anomalies are always likely to return because their genesis is in humans’ primal impulses. This thesis was brilliantly explored by Hirschleifer (2001), who wrote an alternative history in which he asks us to
[p]icture a school of sociologists at the University of Chicago proposing the Deficient Markets Hypothesis: that prices inaccurately reflect all available information … [and] a brilliant Stanford psychologist, call him Bill Blunte, invents the Deranged Anticipation and Perception Model (or DAPM), in which proxies for market misvaluation are used to predict security returns … [leading to] the best-confirmed theory in the social sciences.
This alternative history is no less plausible than the actual history leading to the current dominance of EMH and CAPM.
5. The RAFI Fundamental Index return series in the US, developed, and developed ex US regions begin on April 30, 1984. The RAFI Fundamental global and emerging market indices begin on September 30, 1996. Readers and the investment community at large should be cognizant of the trap of placing too much faith in backtested data, including our own. As explored by Harvey, Liu, and Zhu (2016), Treussard and Arnott (2017), and Arnott, Harvey, and Markowitz (2019), technology and professional incentives have collided and created a boom in “successful” backtests that should be regarded with a great deal of caution. Arnott, Harvey, and Markowitz offer a protocol for limiting spurious data mining in the current era of cheap computational power and machine learning.
6. Over the last five years ending September 30, 2019, value lagged growth by 5.6%, 4.3%, 3.8%, 4.2%, and 3.6% a year in the US, developed, developed ex US, global, and EM markets, respectively.
7. Do value stocks have unprecedented headwinds? Are the growth opportunities for value companies abnormally poor relative to the past? No. The entire shortfall is a result of value becoming less and less expensive as measured by valuation multiples relative to growth, not because growth is in any way “better” than in previous growth cycles.One of us will cover this topic in greater depth in an upcoming journal article. Stay tuned.
8. The FANMAG stocks are the usual FANGs (Facebook, Amazon, Netflix, and Google/Alphabet) plus prior-generation tech highfliers Apple and Microsoft.
9. In the same vein, many investors are unsurprised that the RAFI strategies generally allocate more to energy stocks relative to the market’s allocation. Although RAFI largely maintained an overweight tilt to the underperforming energy sector relative to the cap-weighted index, the sector overall added an annualized excess return of 0.6% a year from July 1962 to December 2018. Why? While the overweight allocation detracted from overall excess return, the impact of security selection more than offset the loss. Systematically rebalancing across stocks in the sector added value over the long run.
10. For interested readers, Arnott and Wu (2012) explored the historical performance of top dog stocks.
11. ExxonMobil beat the MSCI ASWI Index from 1993 through 2002, although Microsoft edged it out of top-dog status. Today, ExxonMobil does not even make the top ten.
12. These include Amazon, Google, Facebook, Microsoft, Apple, Tencent, and Alibaba. Amazon is formally classified as a consumer noncyclical company, but most would agree that its edge is in technology.
13. Exceptions exist, but they are, well, exceptional and include the expropriations of the Russian stock market in 1917, Chinese stock market in 1949, Venezuelan stock market in 1908, and Egyptian stock market in 1952 as well as the near-obliteration of the Japanese stock market in 1943–45 and German stock market in 1940–45 as well as in 1922–25. This is why investors are encouraged to diversify globally!
14. Bob Lovell, the CIO for Crum & Forster Insurance, and founding chairman of First Quadrant was Rob Arnott’s boss/mentor from 1988 to 1993.
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———. 2019. “Bubble, Bubble, Toil and Trouble.” Research Affiliates Publications (July).
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