Is Value Investing Dead?

Vitaliy Katsenelson, CFA, has an excellent post on LinkedIn:  “Is Value Investing Dead?”  Katsenelson concludes that it is not, and he is right, although there might be muted returns to value investing for several more years. 

There is a parallel between commodities and value stocks because both are devalued by monetary creation in the early phases of a bubble market. Something similar occurred in the late 1990s, when gold was bottoming near two hundred, and everyone was saying that Warren Buffett had gone the way of the Brontosaurus.

In the early phases of a bubble market, low interest rates stimulate competition. Hence,  enterprises that are viable in the long term face more competition than otherwise because  the Federal Reserve banking cartel subsidizes inefficient competitors.   In the commodity sector viable mines are forced to compete with mines that the Fed artificially makes viable with low interest rates.  The results are supply gluts. 

At some point increasing competition causes bankruptcies of the less viable manufacturers, natural resource firms, and mines. Given intensifying competition, the subsidized interest rates are no longer sufficient to sustain the inefficient producers.   For value stocks, oil firms, and mines, subsidized output strains the least competitive firms, which ultimately go bankrupt. 

At this point in time, we see depressed value in the gold mining, oil, and value stocks.  The depression in those stocks has lasted a long time because the monetary creation of the 2008-2016 period was exceptionally great. The bubble period might continue for several more years.  Before it ends, I would expect higher valuations in the bubble stocks, recently known as the FAANG stocks--Facebook, Apple, Amazon, Netflix, and Google.  In the 1920s radio and automobile stocks played a similar role. In the 1960s the Nifty Fifty, including American Home Products and Xerox, did.  In the late 1990s the Internet stocks such as Drugstore.com and Beauty.com did.  

As artificially intense market competition ends because of supply gluts, the value stocks survive and enter a less competitive environment; so do the most efficient natural resource firms. In a less competitive environment, they thrive.  

Hence, oil wells, miners, and value stocks are depressed in this period, but they have a bright future.  In all bubble periods, the claim that "we have entered a new era" becomes common.  The mania is fueled by the myopic definition of risk as standard deviation, which is  favored by finance economists.  This statistical definition overlooks longitudinal patterns and the effects of crashes on individual well being and stress.

Late-stage-bubble buyers force up the stock prices of the favored, speculative stocks in what Steve Sjuggerud calls a speculative melt-up. The inevitable crash is worst for the most speculative stocks.  There is some spillover to all stocks because of panic selling, but the value stocks then outperform. 

The most important characteristic to make money is patience or persistence.  Another is focus. These are not characteristics taught or valued in American educational institutions, which function with a win-lose, socialistic mindset and emphasize scientism at the expense of common sense. 

King Bear versus Bullzilla

I subscribe to two newsletters with opposite predictions about the markets:  David Stockman's Stockman Letter and Steve Sjuggerud's True Wealth, published by Stansberry Research. Stockman is predicting declines in a wide range of markets, including tech and energy, while Sjuggerud is predicting bull markets across the board, but especially in tech and China. There will be a "melt up" (Sjuggerud's term) until a correction, which will occur perhaps 18 months from now.

The great investor Howard Marks, in his book The Most Important Thing, says that being right at the wrong time is the same as being wrong, and from a purely financial perspective he is right.   While I'm quoting aphorisms, one that is worth considering is "the trend is your friend." 

Sjuggerud doesn't appear to dispute Stockman's underlying theory:  The Fed and the current monetary regime are a long-term drain on productivity and economic well being, and the bubble economy it has created is little different from other failed bubble economies of the past, such as John Law's Mississippi Bubble in France in the early 18th century.  The ending of a long-term bubble of this kind will not be positive. It may mean long-term stagnation and declining job opportunities, as occurred in Japan, and it may mean a massive crash.

If the trend is our friend, I'm thinking that Sjuggerud's hypothesis is right in the short-run while Stockman's is right in the long-run.  Tech and similar investments will do well until they don't.  The trick is to gain at least something from the short-term bubbles and to get out while the going is good.

The last tech bubble saw the Nasdaq rise to unprecedented heights. According to Wikipedia: "It reached a price-earnings ratio of 200, dwarfing the peak price-earnings ratio of 80 for the Japanese Nikkei 225 during the Japanese asset price bubble of 1991." It's impossible to know just when a bubble will burst, but it seems to me that the current Nasdaq price-earnings ratio  of 18.6 allows leeway for a bubble to proceed.  It is true that the prices of today's glamour stocks are at nosebleed levels, but the general market has a ways to go.