Quarterly Letter 3Q 2022

The 12 months to September 30 were the best for value relative to growth performance since the fall of 2001. It was a huge relief for those value investors who managed to survive the long period of growth ascendance since about 2007. Like many periods of value outperformance, however, it didn’t quite live up to the way that value investors had imagined such a year might be for a couple of reasons. First, while value stocks did outperform growth by a double-digit margin (MSCI ACWI Value beat ACWI Growth by 12.4%), value stocks didn’t actually make any money in absolute terms, falling by 4.4% in U.S. dollar terms (those of you who measure your returns in different currencies may feel a little better about value’s absolute performance). And second, it seems as if growth investing still got all the attention, even if in this case the attention was focused on the spectacular flameouts of a number of high-profile growth stocks and a few high-profile growth investors. Value’s strong performance seemed to be primarily about avoidance of really bad returns rather than any particularly notable successes. While long/short value strategies such as GMO’s Equity Dislocation Strategy were able to generate double-digit positive returns, a quick look at the attribution shows that most of the returns came from the very negative performance of high-priced growth stocks our strategy was short.

Given value’s significant outperformance of growth this year, we have been asking ourselves several questions that we know are also on the minds of our clients. Is there still money to be made in the value/growth trade? Are there better and worse parts of the world in which to be investing with a value mindset today? How tightly do you need to define “value” to get to an interesting group of stocks? And what would happen to value if these stocks don’t revert to historically normal value spreads but stay at today’s levels indefinitely?

Value is still priced for significant outperformance everywhere

As for the question of whether the value opportunity is over, it seems pretty clear to us that the answer is no. Exhibit 1 is an updated version of the valuation of value chart I’ve been showing for the last couple of years.

This chart shows the valuation of the cheap half of the U.S. market against the expensive half, and it’s been renormalized so that the average valuation gap is 1.0. As of the end of September, value was trading at 0.72, which is the 11th percentile versus history. It’s certainly up from where it was a year ago, when we were at the 4th percentile versus history, but far from all the way back to normal. And the U.S. is certainly not an outlier compared to the rest of the world. Table 1 shows the percentile ranking for value versus growth in a variety of regions, sliced in a variety of ways.