Minority AM Liam Zhou: Can value stocks shine again?

Liam Zhou   2021-07-02 本文章364阅读

Growth Stocks continued to outperform Value Stocks in the first half of 2021, despite of heightened volatilities in tandem.

To put the stark contrast in perspectives, the Growth Enterprise Index (GEI) rose 16% year to date, while the CNI Large Cap Value Index (399373.SZ) fell 1% during the same period. Value Stocks, especially Banks, Property Developers and Insurers were hit hard in Q2, printing new share price lows one after another.

Investors are losing patience two years into the Value Stocks’ lackluster relative performance against the Growth stocks. There’re louder questions asked more frequently on “how much longer is the wait for the Value Stocks to shine”?

The Growth Stocks are in a bull market, while the Value Stocks are in a bear market. If you were to buy stocks now, should you choose a stock at its bull market peak or a stock in its bear market trough?

The share price rally in a bull market usually comes at the cost of excessive risk accumulation and diminishing risk-reward ratios. Those who lived through first half of 2015 China A-Share market would have known better.

The share price weakness in a bear market, on the other hand, generally comes with the benefit of extra risk reduction with improving risk-reward ratios The market in 2013 served as the best reminder from A share’s history.

Judging from indicators ranging from valuations to market sentiments, the Growth Stocks are in the peak of its own bull market versus the Value Stocks in the trough of its own bear market. The risk-reward ratios of the two are markedly different. Seeking momentary profit should not be the end goal of any investment. Long term sustainable alpha return always comes from picking the stocks with the good risk-reward ratios.

It is difficult to predict the future timing of investment style rotation, but we can always make the right investment choices by evaluating the risk-reward profiles of different stocks.

Stock price is essentially determined by the marginal investor who are most optimistic. The high growth prospects of the Growth Stocks are inevitably associated with lots of uncertainties and the resulting extremely divided views. Given A share’s current market structure, those who are more optimistic have the buying power to dictate the share price, while the rest who have a different opinion do not have any effective or active way to express their view through share price actions. This contributed to the excessive valuation of the Growth Stocks.     

Excessive valuation will negatively affect the future return in longer term. Looking back at the past cycles of both China and US markets, investing in the Growth Stocks as a whole did not generate alpha, against many investors’ instincts and impressions. Buying Growth Stocks at the peak is even worse as the number of the marginal buyers diminishes quickly. The potential downside triggered by any perceived earning miss is huge.

The Value Stocks have relatively stable growth prospects with less uncertainties and hence less divided views. The share prices are unlikely to be pushed up unduly by a group of extra optimistic marginal buyers. Back testing in both China and US markets has also shown investing in the Value Stock generated long term alpha.

Two years’ underperformance is throwing out the last “swing investors” who often over-react to bad news, much like the prevailing “fears” at the end of a typical bear market. In our opinion, this was the main reason responsible for the share price declines of Banks, Property Developers and Insurers in Q2. It is also our view that, thanks to it, rare and golden opportunities are now revealed to the investors who stand by their principles in the times of test.

Recency Bias is one of the key subjects studied by the Behavioral Finance practitioners. Recency Bias refers to a cognitive bias that favors recent events over historic ones. When it comes to investing, recency bias often manifests in terms of direction or momentum. It convinces us that a rising market or individual stock will continue to appreciate, or that a declining market or stock is likely to keep falling. This bias often leads us to make emotionally charged choices—decisions that could erode potential earning by tempting us to hold a stock for too long or pull out too soon. To not fall victims of it, we must always take a long-term view and remind ourselves constantly that the past two years outperformance of the Growth Stocks has no relation to its future performance especially when its valuation and the market sentiment are at the peak, and vice versa for the Value Stocks.

“Many shall be restored that now are fallen, and many shall fall that now are in honor”, Benjamin Graham quoted from the Horace’s Ars Poetica as a poignant opening for his legendary “Securities Analysis”. We could not echo the same thoughts more.

We do not forecast the market, but base our investment on evaluation of risk-reward ratios. The risk-reward ratio of the Value Stocks presents a golden investment opportunity that comes by once a decade. We are confident of it!