Value investors bet recent market leadership is just the start

Although few corners of the stock market have emerged unscathed in 2022’s dizzying selloff, value shares—traditionally considered those that trade at a low multiple of their book value, or net worth—have held up better than most. By one measure, they are on track to beat shares of fast-growing companies by the widest margin since 2001.

Among the stocks at the top of the leaderboard are traditionally slower-growing businesses like Exxon Mobil Corp., Merck & Co. and Molson Coors Beverage Co. All have notched double-digit gains in 2022, while the S&P 500 has dropped 18%. The big technology stocks that propelled the market’s gains for much of the past decade, meanwhile, have fallen as the Federal Reserve raises interest rates in a bid to tame high inflation.

Mr. Asness, managing and founding principal at AQR Capital Management, and Mr. Arnott, founder and chairman of Research Affiliates, say value stocks are still unusually cheap in comparison with growth, despite their recent run.

“People like me, both for legal and for honesty reasons, should never use the word guarantee, and I won’t," Mr. Asness said in a recent interview. “But I’ve never been more excited about value."

In the days ahead, investors will look to housing, manufacturing and consumer-confidence data to try to gauge the market’s trajectory.

Mr. Asness said the relative cheapness of value stocks gives him confidence that they have a bright future over the next three to five years. AQR modestly tilted many of its strategies toward value stocks in late 2019, he said. The firm managed $117 billion as of the end of March.

Its dedicated value strategy, the Equity Market Neutral Global Value strategy, had a total return of 52.5% this year through May, according to AQR. The S&P 500 lost 12.8% on a total return basis, which includes dividends, over the same period.

Mr. Arnott, meanwhile, said value stocks might be in the early stages of a prolonged period of outperformance relative to growth. Research Affiliates designs investment strategies that were used to manage $168 billion as of the end of March.

“As we move closer to historic norms of relative valuation, I would reserve the right to moderate that view," he said. “But from current levels, I think we’re going to have a stupendous decade and most particularly a stupendous three to five years."

Investors measure whether stocks are cheap or expensive using a variety of valuation metrics. A common way is to compare a company’s stock price with its expected earnings so investors can see what they are paying for a share of profits. One such measure shows value stocks still look unusually cheap.

At the end of May, the Russell 1000 Value index traded at 14.3 times its projected earnings over the next 12 months, according to BofA Global Research. The Russell 1000 Growth index, meanwhile, traded at 22.5 times forward earnings.

That put the value benchmark’s price-to-earnings ratio at 63% of the growth index’s ratio, below the average since the end of 1978 of 71%, the bank’s analysis shows. At the end of November, the value index was trading at only 53% of the valuation of the growth index.

“When value gets very cheap, the snapback is often powerful and fast," Mr. Arnott said. “And we’ve certainly seen that this year."

The leadership by value shares represents a shift in the dynamics that have dominated the stock market in recent times. Inexpensive stocks trailed their growth counterparts for years as investors piled into shares of companies that promised rapid expansion into the future. From 2009 through 2021, the Russell 1000 Value index beat the Russell 1000 Growth index only in 2012 and 2016, lagging behind in the other 11 years.

The arrival of the Covid-19 pandemic in 2020 proved especially punishing for the value trade, as digital companies flourished and portions of the physical economy shut down. The Fed, meanwhile, slashed interest rates to near zero to support the economy, driving investors to seek returns in higher-risk assets. They piled into growth stocks, from blue-chip tech firms to less-proven enterprises, helping the growth index soar 37% that year while the value index edged up 0.1%.

This year has been a different story. Stocks have fallen across the market as the Fed raises rates, but growth stocks have logged particularly steep declines. Higher rates eat into the worth of the far-off earnings they expect.

The Russell 1000 Value index has fallen 12% so far this year, versus a decline of 25% for the Russell 1000 Growth index. That is the largest lead by value stocks at this point of the year since 2002, according to FactSet and Dow Jones Market Data. If the 13-percentage-point lead were to hold through the rest of the year, it would mark value’s biggest annual outperformance since 2001.

The growth benchmark has been dragged sharply lower this year by declines in some of its biggest companies: Facebook parent Meta Platforms Inc. has slumped 49%, while Nvidia Corp. is down 42%, and Amazon.com Inc. is down 30%.

Value gauges, meanwhile, have gotten a boost from a surge in energy stocks, the only S&P 500 sector in positive territory in 2022. Exxon shares have advanced 42% this year, while Chevron Corp. shares have gained 23%. Mr. Arnott said he is overweight energy stocks but has been lightly trimming the positions as energy shares advance.

The energy sector got a high-profile shout out at the recent annual meeting of Berkshire Hathaway Inc., whose chief executive, Warren Buffett, is a longtime adherent of value investing.

“I’m basically in love with Standard Oil," said Charlie Munger, Berkshire’s vice chairman. “I wish the rest of the world worked as well as our big oil companies."

Exxon and Chevron are both descendants of Standard Oil. In recent months, Berkshire has bought shares of Occidental Petroleum Corp. and added to its stake in Chevron. Occidental shares have nearly doubled year to date.

To be sure, it can be dangerous to predict how groups of stocks will perform in the short term. And neither Mr. Arnott, who considers himself a value investor, nor Mr. Asness, who has spoken about the attractiveness of value, say they want to boast about value’s recent run.

“Even though I’m supposed to be a rational quant, I’m a deeply superstitious rational quant and believe the time to gloat in this business is after you’re retired or dead," Mr. Asness said. “So I will not be taking any victory laps. That doesn’t mean I’m not enjoying it."

This story has been published from a wire agency feed without modifications to the text