Printing like a Fed = value dead?

[JCD]

This is a bit of an exploration post on some thoughts on value investing.  I would love to hear thoughts on the topic.

Let's start with my assumptions, which I think are reasonable given recent history:
- Assumption: If you have a 0% interest rate, why not lever up to infinity, if you can get a positive return? If you have a negative interest rate, debt is an asset.
- Assumption: Corporate debt can be rolled over to be set to 0-5%.
- Assumption: If anything goes seriously wrong, the fed will bail out nearly everyone, even if it is indirectly (e.g. Bonds).

In such a world, why would well managed companies, with lots of reserves, prepared for a rainy day be valuable?  Why bother looking at a balance sheet over market or consumer sentiment?  See Netflix for example, with a PE ratio out of this world compared to Disney with a relatively low PE ratio.  Furthermore, why would a down and out company be able to recover beyond cyclical adjustments?  Since everyone is encouraged to be levered to the max, wouldn't such a down and outer be more likely to fall over from debt or lack ability to generate more profits.  Since the fed only bails out everyone when everyone is in trouble, not when an individual is in trouble this down and outer may go bankrupt.

In some sense, if my assumptions are right, the fact that the fed couldn't raise interest rates without causing a recession (see Dec 2018) hints that the fed can't stop playing this game, companies are dependent on cheap debt. The fact the airlines got bailed out shows this "virtuous" circle keeps assets flying high by debt, forcing the fed to keep low interest rates. This means low interest rates are here to stay and thus a well managed company with lots of funds will not be better off during the bad times.

Japan has many zombie companies and has not seen growth in several decades, to say nothing of Japan's central bank buying ETFs.  This is in part due to the government trying to keep these businesses alive.  The US has Russell 2000 showed ~40% of companies with no profits.  Stock buybacks created most of the growth in stock prices over the last hand full of years. This seems to imply the market will not kill of these weaker companies and fed-like institutions are likely to keep them alive on debt for years or decades.

If buybacks dry up, the market will likely not see earnings growth.  Without much growth and without "fake" earns via EPS growth, via buybacks, can value start to do better?  Probably, if buybacks stopped, companies would do better.  But why would buybacks stop in the long run?  Even if they were legally not allowed to buy back shares, they can simply provide dividends instead.  So buybacks or the equivalent will only stop if corporations can't get more debt, an unlikely occurrence.  Thus, this does not save value.

The only other real strong argument for value seems to me to be whenever the existing system goes bust (when the fed ammo quits working).  Is this like playing musical chairs, where as long as the fed can keep adding chairs, everyone can sit when the music stops, but if the fed ever fails to provide seating, then value comes back?  It seems likely that if the fed fails, the entire global world order will change.  There are lots of rumblings about this already due to the fact that many nations around the world aren't able to get enough dollars to deal with their own economic problems.  If the dollar breaks, then I think the question of value is not even close to the top problem investors will face.  Instead, depending on what replaces it, the world might look very different.  The home advantage the fed has in printing will go away as will the market put the fed provides.  That by itself indicates all stocks will be hurt, as will the value of the dollar.  Will value investing then make a come back--probably, but not before a mess of problems show up.

So do you think value can work today?

[Lucky C]

There is also the argument that value is dead, not because of the current unprecedented economic events, but because value investing is now a publicly known and competitive strategy such that an individual has no chance of competing against millions of other value investors, let alone some value investment team working full time at a major investment bank.

Alternatively there is a history of alternating periods where growth stocks outperform value stocks and vice versa. After a period of 5-10 years of growth outperforming value, value has a much better probability of outperforming growth over the next 5-10 years. This does not depend on any prediction or economic analysis, just that the tides turn eventually. One might argue that when it becomes popular to make arguments like the ones you are making, saying that it is pointless to try to be a value investor and one should just invest in growth stocks, that coincides with a turning point (since value is temporarily no longer competitive, but growth is).

Although your line of reasoning for value possibly being dead might not be one that a lot of people are thinking about, overall the herd mentality also seems to be against value, even if everyone has their own unique reasoning. So one always has to question if one is actually part of the herd. Would you be going through this same thought process if value happened to have outperformed growth for the past decade?

[sky]

Try to find companies with earnings from the Eurozone.

[JCD]

There is also the argument that value is dead, not because of the current unprecedented economic events, but because value investing is now a publicly known and competitive strategy such that an individual has no chance of competing against millions of other value investors, let alone some value investment team working full time at a major investment bank.

Not to just dismiss this idea, but if that was the case, shouldn't value have died about 70 years ago then, given this thesis being documented back in the 1930s?

Although your line of reasoning for value possibly being dead might not be one that a lot of people are thinking about, overall the herd mentality also seems to be against value, even if everyone has their own unique reasoning. So one always has to question if one is actually part of the herd. Would you be going through this same thought process if value happened to have outperformed growth for the past decade? 

I agree that this does happen to seem to be following the herd view, although for different reasons.  I'm not exactly sure that "growth" is a good idea either.  I suppose in part I'm thinking about the post in inflation vs deflation viewtopic.php?f=3&t=11294 .  While it wasn't written in those posts, if we see inflation, debt becomes worth less, which then implies the high debt companies will gain in value.  Think AT&T, not exactly a high growth stock that everyone is buying today, but admittedly debt heavy companies historically tend to be growth side of the fence. The big exception is tech companies, which is where most of the stock market is dumping their money today.

Deflation traditionally comes in the form of commodities like oil or financials like stock prices or writing down debt.  In the case of deflation of oil, companies that can lock in lower costs will win, which would be value stocks in theory.  By value I'm talking about price to book, a common academic measure.  With high book value, they should be able to raise more debt to lock in low prices of commodities.  That might work out well in the short run, but in the long run, the US Gov't is going to have to inflate the debt away, which seems like it will hurt those with low debt.  See Ray Dalio's comments on this https://www.youtube.com/watch?v=miRVVsjL2dU .

So to directly answer your question, I actually still look for value investments, but I try to remain aware of the macro environment.  I don't really care for growth stocks, I don't tend to understand them or feel like they require too much faith that the world won't change.  I'm just asking myself if value investing can work in this macro environment.  My thesis is that the fed is breaking value investing and that might end up meaning that companies with debt, may actually end up doing better in the end.  This doesn't require me to buy growth, just consider companies with lots of debt that can still raise a lot more.  On the other hand, if inflation cannot be summoned (see inflation vs deflation above), then this strategy will end up being a terrible idea.

[black_son_of_gray]

@OP - I think you bring up very valid points.

Call me an old-school traditionalist, but when you say "value investing", I interpret that as just "investing". An investment seeks a return at a fair price relative to the risks. I personally take "return" to be "giving money back to investors/owners" (i.e. dividends, distributions) or in retained earnings/reinvestments in expanding the company, rather than simply "yay, the share price went up!". (It's like I read Benjamin Graham a decade ago and can't shake it!) If a large fraction of companies are zombies, they aren't providing returns, so I want no part in them. They aren't investments. If the interest rate is 0% and/or interest rate spreads are very close to 0, then there is no mechanism for pricing risk. Which makes the living and the zombies difficult to distinguish, and generally clouds over investment decisions. If the Fed may or may not (at their whim) backstop prices for companies that may or may not deserve to fail through unlimited asset purchasing, I just don't know how that's a functioning marketplace with real price discovery. Without having some idea of what is a fair price, I don't think I can make good investment decisions. Considering the whole basket of economic uncertainties surrounding the coronavirus, the risks to businesses going forward is more uncertain than normal (probably more uncertain than any point in time in my life OR my parent's life), and generally speaking, the greater the uncertainty of risks, the more return you should demand as an investor. I don't see offers of particularly enticing returns relative to that uncertainty happening AT ALL right now. Just the opposite.

Much of the buzz and commentary around the stock market is either blind to these issues or conveniently overlooks them because their jobs depend on it. Just yesterday I saw a Barron's article touting some companies (that's all Barron's is, BTW) with a little chart showing their 2021(!) estimated Forward P/Es. Pardon the French, but how deep is the ass that they're pulling these numbers out of? The same issue showed 12 years of a biannual fund manager's survey where they asked "is the market [undervalued/fairly priced/overvalued] right now?" The unintended take-home message to me wasn't what the fund manager's thought (most think the market is undervalued right now ), it was that at no point in the last 12 years have a decent number of those managers thought the market was overvalued.

So I'd go further and say that it isn't simply "value" stocks that have some real issues, it's the whole stock space (thinking US, here, but other places also have issues.) My approach, perhaps controversial - particularly among the FIRE community, is that if I can't make the investments (as I define them) that I want, I'm just completely out of that game. I've been out of stocks since Sept. 2018 for that reason*. Maybe I'll be out of stocks for while. Who knows? You don't have to play a game with rules you don't like just because everyone else is. That said, if you want to speculate on price movement, momentum, Fed policy decisions, Keynesian beauty contests, more power to you! It's a completely valid thing to do with your money. I don't have any mental hangups over traders, and I think buying options is a very sensible activity. Meanwhile, I'm happy to sit on the sidelines with my boatload of FU money while other people play.

*This isn't to say that somewhere in the US market there isn't something worth buying: there probably is a needle somewhere in the haystack. I just don't want to go hunting for it right now until a lot of the hay has been removed.

[7Wannabe5]

I think it depends on whether Chinese style Politial Capitalism translates well in Africa. If an 8 year old African who is below $2 /day (adjusted) now makes it to $11/day (global middle class) by age 18 (2030), what will he spend his wealth on?

Obviously, if the global economy goes in the other direction, then the 8 year old African boy will likely be dead.

[Mister Imperceptible]

There is always a bull market somewhere. The instruments for unlocking returns on capital change. The super-investors of Graham-and-Doddsville optimized for the instruments available to them at the time. The environment is now different, therefore, the instruments are different.

Just a few landmarks....

1971: Nixon Shock
1982: SEC passes Rule 10b–18
1999: Glass-Steagall Act repealed
2008: Heavy use of QE normalized by central banks

Potentially dangerous to stick to playing by the same rules, when they keep changing the rules. But the same principles of identifying mispricing apply. Where can I buy a dollar for 65 cents?

Inverse Warren Buffett

[JCD]

@Mister Imperceptible

There is always a bull market somewhere. The instruments for unlocking returns on capital change. The super-investors of Graham-and-Doddsville optimized for the instruments available to them at the time. The environment is now different, therefore, the instruments are different.

Don't get me wrong, I'm not saying there aren't potential ways to make money now. In fact, if anything, I've started to move towards a more Chris Cole like portfolio, which looks a bit like what you've described as your portfolio, but with some effort to betting on the deflation/value side as well. However, I also know there are lots of people who get excited by technical analysis in these sorts of markets (like this or this). I'm not saying technical analysis can't work, it might be a way of reading human psychology, but it sure looks like mumbo-jumbo to me. I suspect that this is a market where technical analysis and trading makes sense, even if I have no skill in that game. Indexing also looks pretty bad to me right now, but again, who am I to say it is dead?

Just a few landmarks....

1971: Nixon Shock
1982: SEC passes Rule 10b–18
1999: Glass-Steagall Act repealed
2008: Heavy use of QE normalized by central banks

Having only lived through one of these as an adult, I feel like I have only limited understanding of those events, even if I know of them from history. Living through this event have been valuable to deepening my understanding of what it is like to live through those sorts of events. My issue is not so much the "can I stay the course" after making a investment choice, but a doubt has set in around the "buy the dip" and "buy value" games within these circumstances.

As I learn more from history, the more possible outcomes become "obvious". Inflation, hyperinflation, deflation, the dollar losing its magic status as reserve currency, pension funds failing, war and so on. Each of those has a different set of circumstances has investments that will work better or worse. So it seems like unless I can divine the macro outcome, the best I can say is what circumstances are likely to not occur and under bet in that rather than try to over bet in what I think will be the outcome of the future. I wanted to see if this audience thought I was wrong in the logic and historical analysis that value is dead unless the fed lets or allows deflation happen. Basically, is my macro analysis reasonable or is there some obvious flaw? Is there an opposing thesis? Having other views will help me grow and so I'm looking for any data I can get.

@7Wannabe5

I get the sort of global warming kills us all/kills the poor thesis. I also get the sort of Chinese build real assets rather than hold our paper assets. Assuming the Chinese hold access to that billion people with a GDP per capita of ~2k in today's dollars (inflation roughly halves dollars in 20 year periods), it certainly isn't chump change, but it also isn't huge growth. I sorta see where this might be going but I'm not sure how this relates to value specific investing. Can you clarify your thoughts?

@black_son_of_gray

An investment seeks a return at a fair price relative to the risks. I personally take "return" to be "giving money back to investors/owners" (i.e. dividends, distributions) or in retained earnings/reinvestments in expanding the company, rather than simply "yay, the share price went up!".

I have left the definition vague to allow for different views. I tend to see value investing as investing in temporarily "troubled" assets that currently have a lower valuation, in hopes that they recover or even overcome their previous reasonable levels. Think REITs in the 2008 crisis, it wasn't like housing wouldn't be needed after the crisis ended. I know Buffet and others have a different, valid view of value investing and I think that too is valid, it just isn't what I tend to think of.

[Mister Imperceptible]

Value as practiced and popularized by Buffett and Graham’s other disciples occurred both after Depression/WWII, when stocks were shunned from bad experience and therefore to be had cheaply, and in post-WWII US prosperity, with organic economic growth, sound money backdrop, manageable corporate debt levels, no buybacks and less central bank intervention. Buying assets below replacement cost was frequently possible in that environment. Is that environment repeatable without a purge, if at all? And what actions will be taken/are being taken by those in seats of power to try and stop that purge from happening? How will those actions impact your approach? Remember those actions will happen whether you agree with them or not.

[Lucky C]

Not to just dismiss this idea, but if that was the case, shouldn't value have died about 70 years ago then, given this thesis being documented back in the 1930s?

What I mean is if you take "value" to mean an index of stocks like VTV, as opposed to a growth index like VUG, there is no reason to believe that you should outperform the market simply by holding that value index at all times. Now I know you said you don't think growth is a good idea either, but here growth is defined as the opposite of value, so by not betting on value you are actually betting on growth. You mentioned Netflix which is the #10 holding in VUG and Disney which is the #11 holding in VTV, so if you are talking about buying a basket of stocks with properties more like Netflix and less like Disney, as you add more stocks to your portfolio you will be further approximating VUG's performance relative to VTI, while moving away from VTV's performance relative to VTI.

Anyway if you look at historical data that are based on value/growth indices, there are periods when value outperforms growth and other periods when growth outperforms value. Going by MSCI's USA Value index vs. USA Growth index, with 45 years of data:
MSCI USA total return: 11.3% CAGR
MSCI USA Value total return: 11.2% CAGR
MSCI USA Growth total return: 11.2% CAGR

So if you held a constant allocation of any combo of value and growth funds that tracked the MSCI data perfectly, you would actually slightly underperform the total USA market while probably incurring higher fees vs. a broader index fund.

To outperform the market, you would need to switch between value and growth at the right times. You would want to own the value index in the late 70s; there wasn't much difference in value vs. growth in the 80s and early 90s; you would want to own the growth index in the late 90s; and you would want the value index from 2000 to 2007. Finally, you would want to be a growth investor from 2008 until now, which looks like a record long streak of growth outperforming value coinciding with this record long cycle. My point is that without taking any predictions into consideration and just looking at how value and growth alternate in outperformance, usually changing at bull/bear turning points, and looking at how growth stocks are much more popular than value stocks now, doesn't it make more sense to rebalance more toward value stocks (or at least away from growth stocks) for the next few years?

Now if you're not talking about buying a value/growth index and instead picking stocks to make a portfolio that will significantly differ from VTV/VUG, your performance will stray from the value/growth index but it could go either way. There will always be value stock pickers who outperform the value index and growth stock pickers who outperform the growth index, but you should assume you are more likely to underperform the index unless you're one of the pros with a lot of experience. Regardless, even if you made yourself a portfolio of growth stocks that outperforms VUG, you'll have a harder time beating the S&P500 if we're entering a period when value beats growth for several years (you would have had an easier time just buying VTV).

Lastly, looking at the MSCI WORLD indices which also go back 45 years, value has more consistently outperformed growth on a total return basis (but not on a price basis). However the difference in CAGR is only 1.27% and there are still periods when growth outperforms value anyway. Most of value's outperformance came in the 70's and 80's. No strong case to believe that growth or value will outperform the other over the span of decades in international/emerging stocks. But again the case can be made that value may be more likely to outperform over the next several years after such a long growth streak, whether talking about USA stocks or international/emerging.

[Lucky C]

I tend to see value investing as investing in temporarily "troubled" assets that currently have a lower valuation, in hopes that they recover or even overcome their previous reasonable levels.

If you define value more narrowly to include only low valuation stocks due to some serious trouble, I think that is adding a lot of risk without easily being able to test how it would have done in the past. Think survivorship bias. You mention the hope that the troubled companies recover, but what about the risk in only investing in companies that are more likely to go to zero than other companies? When do you deem a company troubled enough to enter, and is it ever too troubled to abandon your position? When has it recovered enough to sell in order to buy a more newly troubled asset?

With a simple value index like VTV, your top 10 holdings would be companies that are not likely to disappear completely:
Berkshire Hathaway Inc. Class B
Johnson & Johnson
Procter & Gamble Co.
JPMorgan Chase & Co.
UnitedHealth Group Inc.
Intel Corp.
Verizon Communications Inc.
AT&T Inc.
Merck & Co. Inc.
Pfizer Inc.

But if instead you go after (for example) oil companies and cruise lines, you are taking on a lot more risk without having any idea how likely you are to outperform the market. You asked me wouldn't value be dead since around the 1930's, and I say that if you're talking about early-Warren-Buffett-style value investing in seriously troubled companies, maybe value investing has never "worked" in a way that anyone can do it. Buffett turned around Berkshire Hathaway by transforming it into something completely different, but don't ignore all the textile mills that went out of business because they didn't have a rich guy take majority control and turn them into insurance companies. Furthermore, "In 2010, Buffett claimed that purchasing Berkshire Hathaway was the biggest investment mistake he had ever made, and claimed that it had denied him compounded investment returns of about $200 billion over the subsequent 45 years."

In summary, I don't know if there's evidence that buying companies in financial trouble has achieved any outperformance vs. buying a broad basket of (mostly financially healthy) stocks. There is, however, evidence that you can outperform by tilting more towards value/growth using a simple index fund, if one style has had a long streak of outperforming the other and especially if we're at an economic turning point. Since value or growth streaks tend to last several years, it also may make more sense to wait for a year of outperformance to make the switch or increase allocations, in order to avoid being too early.

[JCD]

Buying assets below replacement cost was frequently possible in that environment. Is that environment repeatable without a purge, if at all? And what actions will be taken/are being taken by those in seats of power to try and stop that purge from happening? How will those actions impact your approach? Remember those actions will happen whether you agree with them or not.

@Mister Imperceptible

I started writing this as a specific reply to my own investing ideas, but decided it was better to be generic and capture the kinds of thinking I have gone through.

Roughly speaking there are four different states a financial asset can have:
-Going up in absolute value
-Going down in absolute value
-Staying at the same  absolute value (or within some range)
-Dead/0 value

This is not dependent on time period, this is just a general statement of what prices can do.  Given different periods of history we see different styles that work or fail.  Buy the dip for example has worked wonders for the last 40 years, but failed during the 1930s.  Selling calls also has similar problems when done robotically.  The question is, what is this period like in the past, which tells you which strategy will work well.

My doubt is that value investing is likely to work in this period largely because of the word "absolute".  If your liabilities turn from 50% of your total expenses to 0% due to the debt being inflated away then you will be better off than the entity which paid off its liabilities years ago and is now sitting on cash.

So what are my options?
- Buy gold/silver/etc and bet on inflation directly in a sort of velocity of money kind of way.
- Buy equities and bet on asset inflation in a QE again kind of way.
- Hold cash and bet on deflation in a fed fail kind of way.
- Buy up sectors/stocks assuming the world has changed for good (e.g. Tesla).
- Buy down sectors/stocks assuming reversion to the mean (e.g. GM)
- Use non-recourse leverage to bet without putting all my cash at risk (e.g. "hedging")
- Sell insurance at what I perceive as a fair price assuming various outcomes.
- Buy high debt companies with high assets assuming inflation will save them.
- Buy low debt companies assuming deflation will make them the winners.
- Buy volatility assuming that assets won't trade in a range.
- Buy high dividends assuming that assets will trade in a range or grow, and dividends will stay safe.
- Buy on sentiment regardless of price (e.g. greater fool theory)
- Short a stock to 0 because it is a fraud.

My list could go on, heck I didn't even capture currency issues.  In some sense these are all just tools I have in my tool box.  In effect though, these are just wrappers around "why" or "how" I think one of the four states for an asset will happen and how I can profit from that.  So to me, it is more important to have a sense of where you are and make a strategy of what to do about it.  The "where" element of course is rarely an absolute, like it is in geography, but more of a probabilistic framework of what is likely to occur. Then take that and put the skills you possess to implement that strategy (aka tactics).  For myself, I tend to do this in a more tilting format rather than an all in bet, but I think that goes into temperament, yet another element of investing not connected to the evaluation of the situation but the response you are willing to implement.  I'm not sure I've captured the essence of your question, but it captures some of my thoughts on how I do my investing.

[JCD]

@Lucky C

What I mean is if you take "value" to mean an index of stocks like VTV, as opposed to a growth index like VUG, there is no reason to believe that you should outperform the market simply by holding that value index at all times. ...  Buffett turned around Berkshire Hathaway by transforming it into something completely different, but don't ignore all the textile mills that went out of business because they didn't have a rich guy take majority control and turn them into insurance companies.

Yes, I know Warren Buffet moved from last puff cigar butts to good companies at fair price.  I am not doubting that dividing the world up into 50/50 splits is one way of measuring the difference between value and growth, but one reason for doing it that was is that index manufacturers can't easily implement indexes for stocks without dealing with small companies that have few shares, that is to say companies at higher risk.  That is why I pointed out that indexes have the same stock in both "value" and "growth": viewtopic.php?p=207208#p207208 .  So I am somewhat dismissive of the statistics generated by the large indexes.

That being said, I intentionally didn't give my definition of value investing because I get it is a more esoteric definition than most use and I'm not sure that my definition makes any difference.  Basically the value community, people like Joel Greenblatt or Tobias Carlisle claim they have not been beating the market in the last number of years, but they did better than the generic value index by focusing closer to the troubled stocks side of the fence.  The broad value index has also been failing relative to growth for a while, as you pointed out.  Buffet's relative growth has been poor compared to the QQQ (tech heavy, growth index).  Here is the data I grabbed from a quick googling.  

Dec 2009-Now:
~185% - BRK
~385% - QQQ

If you define value more narrowly to include only low valuation stocks due to some serious trouble, I think that is adding a lot of risk without easily being able to test how it would have done in the past. Think survivorship bias. You mention the hope that the troubled companies recover, but what about the risk in only investing in companies that are more likely to go to zero than other companies? When do you deem a company troubled enough to enter, and is it ever too troubled to abandon your position? When has it recovered enough to sell in order to buy a more newly troubled asset?

Finally, let me address one element that might create confusion.  I said troubled, but not very or seriously troubled.  For example, GM might be troubled when in a recession with low profits, then quit being troubled when the world recovers.  That view of troubled is not just the last puff, but rather companies that are just in trouble for a few years.  Yes, they can fail (see GM), but they can also double in price due to being valued near or below book value.  If you take Tobias's numbers, I believe he claimed 2% of his holdings go to 0 and in or around 2008-2017 he out performed the market.  I'm not going to look up the exact numbers, just saying that data does exist.

[Lucky C]

Some data/charts to back up my "value is due for a comeback" view:
https://www.twocenturies.com/blog/2020/ ... ep-history