GROWTH VS. VALUE

It is widely accepted that the valuation gap between value and growth stocks is historic. Bloomberg writes “value investing is a vanishing trade for more than a decade as the strategy has misfired again and again.
Legendary hedge fund manager David Einhorn states “the valuation be damned boom in passive investing has fundamentally broken the markets, putting many active managers out of business.”
Einhorn further states “the massive proliferation of indexing undermines everything from price discovery to corporate governance as passive investors have no opinion about value,” further stating passive investing “is worse than Marxism” given this lack of price discovery.
There have been brief periods when value did outperform however as inferred these periods were fleeting.
Money ultimately gravitates where there is less risk and more reward.
The last 14 years have been historic as the government has intervened in the markets and the economy at a level never experienced. For example, quantitative easing. The outcome was not what analysts had expected.
An argument can be made the markets and [perhaps the economy] are in their nascent phase of returning to normal. The average inflation rate since WWII is 3.3%. The average two-year Treasury yield for the same period is about 4.5%.
Depending upon the index used, inflation today is around 3.75% and the two-year Treasury is around 4.80%.
Interest rates are the largest component of most valuation formulas. Interest rates at 0.00% dictate a higher valuation of current and expected cashflows. Higher interest rates dictate a lower valuation.
The Federal Reserve has stated a 2% inflation rate is its target. Inflation is a two-part phenomenon; too much money chasing too few goods fearing higher prices tomorrow. Inflation has a monetary and phycological tenant.
The major reason why the Fed picked a 2% inflation target 10-12 years ago is because inflation was under 2% and it was the Fed’s attempt to increase inflationary expectations. It did not work.
Today many believe a 2% inflation is normal. As history states, it is not.
The valuation of the indices is skewed by the largest capitalized companies, a result of passive investing. The remainder of the market is perhaps appropriate or undervalued.
There is going to be a point when risk-free investments (i.e. short term Treasuries) will offer an alternative to passive equity vehicles. It is perhaps at this juncture the indices will come under pressure from the lack of new funds gravitating to the indices amplified by the liquidation under the simple guise that a short-term Treasury offers a risk-free return approximately that is 75% of that of the long term return of the S & P 500.
Einhorn made the comment “a return can come from the company itself rather from other investors” referencing the significance of share repurchases and dividend increases by value companies.
Change is the only constant. It is the velocity of change that is different. The environment will change but the appropriate question is when.
Last night the foreign markets were mixed. London was up 0.40%, Paris up 0.95% and Frankfurt up 0.41%. China was down 0.61%, Japan down 1.63% and Hang Seng down 0.90%.
Futures are flat as markets are seeking a catalyst. The 10-year is 6/32 to yield 4.48%.