One of history's most popular stock-trading strategies has been getting crushed - but Bernstein says it's found a way to save it
- Value investors have watched the rest of the market run laps around them for much of the nine-year bull market, as other traders have continuously piled into proven winners.
- Bernstein has identified a variation of the value trade that it said should be much more competitive relative to the broader market.
Based solely on how it's defined, you'd assume value investing would be a winning proposition.
Since it involves buying stocks that are trading below their intrinsic values, it would seem to fit the age-old investing mantra of seeking bargains and then waiting for the inevitable rebound as the shares revert to fair value.
But what if the stocks never recover? What if they're trading lower for a sensible fundamental reason, and simply aren't worth as much as once thought?
That type of situation - commonly known as a "value trap" - is a very real risk for value investors. For evidence that sometimes these struggling stocks don't rebound as planned, look no further than their relative performance throughout the nine-year bull market.
Value stocks have lost a cumulative 40% relative to their expensive peers worldwide since 2009, and have trailed the broader market by 17% over the period, according to data compiled by Bernstein.
The reason why is straightforward: As stocks have climbed higher in seemingly unstoppable fashion, there's been no reason to seek bargains.
Proven winners - most notably in the mega-cap tech space - have continued to dominate. And as traditional measures of valuation have gotten stretched, investors have shrugged and stayed the course, citing robust profit growth and easy lending conditions. That's all come at the expense of the value trade.
Fortunately for value enthusiasts, Bernstein has identified a variation of the trade that's performed far better during the bull market.
The solution
In order to arrive at a more superior, more nuanced version of the traditional value trade, Bernstein adjusted it to account specifically for fundamentals. And to do that, the firm ran a regression to figure out how much of a stock's relative price-to-book (P/B) multiple was explained by sector-specific characteristics.
Once that was complete, Bernstein was able to pinpoint a key statistic: the residual, or unexplained, portion of the multiple. By the firm's thinking, this is a truer measure of how mispriced a stock is. When compared to returns for broader value universe, the results spoke for themselves, as you can see in the charts below.
"Investing on the basis of such 'residual' multiple results in higher returns and lower volatility compared with the simple P/B factor," Alla Harmsworth, Bernstein's head of global quantitative and European equity strategy, wrote in a client note.
With that established, which areas of the market best fit the bill? Bernstein's screen suggests that in the US, industrials, consumer staples, discretionary, and telecoms are cheap versus their fundamentals. It's a different story in Europe, where healthcare stands above the rest.
So if you're a value-trade loyalist looking for opportunities in a seemingly desolate market, consider those areas, which should offer higher returns and lower volatility than more traditionally define value stocks - at least for now.