Lesson 4 of 7
Value's long drawdown
After 2007, cheap stocks trailed expensive ones for an unusually long stretch. Researchers who studied it in 2021 did not fully agree on why.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- After 2007, stocks priced cheap by book-to-market trailed expensive stocks for a stretch longer than most earlier dry spells.
- Three papers published in 2021 looked at value's weak run and reached different emphases on why.
- Trailing the market by even a small amount, year after year, compounds into a large gap, which is why a long dry spell needs a reason to hold on written in advance.
Cheap stocks trailed expensive ones for an unusually long stretch after 2007, long enough that several researchers asked in print whether the value premium was still real. Three papers published in 2021 looked at value's weak run and did not fully agree on the answer.
The same drawdown, examined three ways in 2021
- 2007The stretch beginsStocks cheap by book-to-market began a run of trailing expensive stocks that lasted longer than most earlier dry spells on record.
- 2021Fama and FrenchFound value premiums much lower in the second half of July 1963 to June 2019. Month-to-month returns vary enough that they could not reject equal premiums in both halves.
- 2021Arnott, Harvey, Kalesnik and LinnainmaaTraced the drawdown to two sources: book value that leaves out intangible assets, and value stocks getting cheaper still against growth stocks. The second was the larger.
- 2021Israel, Laursen and RichardsonCalled the claim that value investing was dead premature.
Longer than the usual dry spell
Value's edge has never arrived every year. The long-run studies also show years, sometimes several in a row, where cheap stocks trailed expensive ones. What set the years after 2007 apart was length. The underperformance ran longer than most of the earlier dry spells in the same data, which is what drew several research teams back to the same question, in the same year.
Same drawdown, different emphasis
Fama and French, revisiting their own value premium in 2021, split July 1963 to June 2019 into two halves. Value premiums were much lower in the second half. But year-to-year returns already vary so much that they could not reject the idea that the expected premium was the same in both halves.
Arnott, Harvey, Kalesnik and Linnainmaa found two causes. Book value leaves out intangible assets, so asset-light companies look dearer than they are. And value stocks fell further in price relative to growth stocks, which by their measure explained more than the whole shortfall.
What a small yearly gap compounds into
A drawdown does not need to be dramatic in any one year to matter. A small, steady gap compounds into a large one. That is exactly why a long dry spell needs a reason to hold on, decided before it starts.
Check yourself
What made the years after 2007 stand out in value's history?
- Cheap stocks fell in absolute terms every single year
- Cheap stocks trailed expensive ones for an unusually long stretch
- Researchers stopped studying the value premium entirely
Show the answer
Answer: B.
Value has always had losing stretches. What set this one apart was its length compared with earlier dry spells in the same data.Comparing the two halves of July 1963 to June 2019, Fama and French found that the value premium in the second half...
- Was reliably higher than in the first half
- Was much lower, but not statistically distinguishable from the first half given how much returns vary
- Had permanently reversed sign
Show the answer
Answer: B.
Value premiums were much lower in the second half. But month-to-month returns vary enough that they could not reject the idea of an equal expected premium in both halves.Trailing the market by 3 percentage points a year for ten straight years, ending each year with 97 percent of what matching the market would have given you, leaves you with about what share of the relative wealth?
- 97 percent
- 74 percent
- 30 percent
Show the answer
Answer: B.
0.97 to the tenth power is about 0.737. A gap that looks small every year compounds into a large one over a decade.Sources
- Fama and French, "The Value Premium," Review of Asset Pricing Studies, 2021.
- Arnott, Harvey, Kalesnik and Linnainmaa, "Reports of Value's Death May Be Greatly Exaggerated," Financial Analysts Journal, 2021.
- Israel, Laursen and Richardson, "Is (Systematic) Value Investing Dead?," Journal of Portfolio Management, 2021.
What this leaves out
- Each paper's own statistical argument is more detailed than one line here can hold, and the three disagree on emphasis.
- Nothing here says whether the drawdown described has ended, or whether a similar one will happen again.
- The compounding example uses a round, invented gap of 3 points a year, not any period's real, measured gap.
- Nothing here is advice about any security or a forecast of future returns.