Ben Inker, GMO – Dispelling Myths in The Value vs. Growth Debate (The Best Investment Writing Volume 6)

Episode Summary

Executive Summary: Ben Inger of GMO argues that the recent growth rally does not invalidate value investing. He dismantles seven common objections—reopening, rates, accounting quality, value traps, growth superiority, secular growth dominance, and low-growth economics—using historical returns and valuation data to show that extreme growth prices are hard to justify and that value still offers better long-term expected returns.

Main Topics: Market reversal after a strong value run (Priority: 5/5): The talk opens with the sharp shift from value leadership in early 2021 to renewed growth dominance in late Q2 and July, framing it as a normal but painful reversal rather than proof that value is broken. Why value outperformance often includes sharp growth rebounds (Priority: 4/5): In past major value cycles, growth had some of its best relative months inside broader value-led periods, so short-term growth surges do not negate the larger value trend. Debunking macro explanations for growth leadership (Priority: 5/5): Inger addresses claims that reopening, falling rates, or slower GDP growth mechanically favor growth, arguing the evidence is weak or inconsistent and that these factors do not justify a permanent growth edge. Updating value for modern accounting realities (Priority: 5/5): He agrees that old accounting metrics are flawed in an intangible-heavy economy, but says the solution is better value models, not abandoning valuation discipline. Value traps versus growth traps (Priority: 4/5): The transcript argues that both styles suffer from traps, but growth traps are often more painful because disappointed growth expectations get repriced more severely. Why expensive growth is risky even when winners are huge (Priority: 5/5): He concedes that exceptional companies like Amazon can compound massively, but emphasizes that paying extreme multiples requires extraordinary outcomes that most companies do not deliver. Secular outlook: valuation matters more than narrative (Priority: 5/5): GMO’s view is that today’s value/growth spread is extreme and long-term expected returns favor value, especially after the growth rerating has already gone far.

Key Arguments: Recent growth outperformance after a value rally is a normal reversal seen in prior value-led eras; it does not prove a regime change. There is no strong relationship between economic growth and value-minus-growth returns; the correlation with quarterly GDP growth is insignificant at -0.07. Falling bond yields may have helped growth recently, but over time bond yield changes explain only a limited share of the variation in value/growth returns. Modern accounting is imperfect, especially for intangible-heavy businesses, but GMO has rebuilt financial statements and created improved valuation models rather than abandoning value. Value and growth both suffer from “traps,” and growth traps are actually more common in markets like the internet bubble and more painful on average (-13% vs. -9.5% annual underperformance versus their universes). Exceptional growth winners exist, but most high-multiple stocks do not deliver sufficient future growth to justify valuations; stocks above 10x sales have underperformed the market by about 4% annually since 1980. A permanent secular premium for growth is hard to justify because it would imply investors continually underprice growth stocks and overprice value stocks for decades. Slower aggregate economic growth does not automatically imply better growth-stock returns; historical rebalancing, payout behavior, and relative valuation still matter. The recent growth rally has widened already extreme valuation gaps, improving opportunity for long-only value portfolios and long-short dislocation strategies.

Data Points: Russell 1000 Value vs. Growth (Q2 2021 as of June 3): Value ahead by 1.6% - The initial quarter-to-date comparison before the late-June/July reversal. Russell 1000 Growth vs. Value (late June through July 2021): Growth +11%, Value -0.7% - The reversal that triggered concern among value investors. Value outperformance in major historical rallies: U.S. large-cap value outperformed growth by 94% (1973-1970 as stated) and 114% (2000-2002) - Used to show that even strong value periods contain sharp growth rebounds. Best growth months during value-led eras: 6 of the best 10 months for U.S. growth vs. value occurred in those two periods - Illustrates that growth rallies often happen inside value regimes. Correlation: value-minus-growth vs. quarterly GDP growth: -0.07 - Shows weak relationship between economic growth and relative style returns. Value/growth return variance explained by bond yield changes: 20% - Changing bond yields explain only a limited portion of relative performance. Probability a stock is a value trap in a given year: About 30% - Trap prevalence is material but not unique to value stocks. Average annual underperformance of value traps: -9.5% per year versus the value universe - Measures the pain from holding value traps. Average annual underperformance of growth traps: -13% per year versus the growth universe - Shows growth traps are even more costly on average. Amazon investment return over 20 years: $1 became almost $267 - Example of an extraordinary growth winner. Amazon price-to-sales drawdown after the 1999 peak: Almost -93% - Illustrates the risk of paying extreme valuations. Returns after waiting for Amazon to fall below 10x sales: 89x initial investment - Shows better entry prices can dramatically improve outcomes. Stocks trading above 10x sales: Underperformed the market by 4% per year since 1980 - Supports the warning against extreme valuation multiples. Real market gain for the S&P 500 over 41 years vs. 10x-sales cohort: About 30x vs. less than 4x - Compares long-run compounding of the broad market versus very expensive stocks. Share of U.S. stock market above 10x sales today: 25% - Near-record concentration of highly valued stocks, second only to the dot-com peak. U.S. GDP growth, 1983-2006: 3.4% per year - Represents the stronger earlier growth regime. U.S. GDP growth since 2006: 1.5% per year - Represents the lower-growth era discussed in the argument. Value outperformance vs. market, 1983-2006: Over 5% per year - Historical context for stronger value-era returns. GMO equilibrium assumption for value vs. market: Value +0.5% per year, growth -0.5% per year - Current long-run return assumptions referenced in the conclusion. Valuation spread vs. historical average: Value trading at a 40% discount to its historic average relationship with growth - Indicates extreme relative cheapness for value.

Pivotal Quotes: "At these relative valuations, our long-term bet is the opposite." — Ben Inger: Conclusion, summarizing GMO’s stance that value—not growth—offers better expected returns from current prices. "The right response to the problem is not to give up on value as a style, but to build better value models." — Ben Inger: Response to the criticism that traditional accounting has become less useful in an intangible-driven economy. "Investing where it will take something extraordinary to earn a good return has generally been a bad idea." — Ben Inger: Discussion of stocks trading at extreme multiples, especially over 10x sales.

Implications: For investors, the episode argues that style rotations do not change long-run valuation math. GMO sees the current spread as favoring value, especially if growth premiums have already been heavily bid up.