Examining the Arguments Against Value Investing

Episode Summary

Executive Summary: The episode revisits the “case against value stocks,” focusing on why value may continue to underperform despite recent strength. The hosts debate structural headwinds including low rates, passive flows, fewer recessions, factor crowding, and value’s exposure to less innovative companies, while also acknowledging that cyclical inflation/reopening forces could still trigger a meaningful value rebound.

Main Topics: Why revisit the case against value now (Priority: 5/5): Jack explains that recent value strength prompted him to re-examine his thesis and stress-test his own beliefs rather than assume the recent rally confirms a lasting turn. Interest rates, Fed policy, and factor returns (Priority: 5/5): The discussion argues that ultra-low rates can favor growth over value by boosting long-duration cash flows and pushing investors toward riskier, high-growth assets in search of return. Recessions as a source of value outperformance (Priority: 4/5): Value tends to shine after recessions, but the hosts argue that a more stable macro regime with fewer recessions could reduce the number of powerful value rebound periods. Crowding and the popularity of value (Priority: 4/5): A key concern is that value’s intuitive logic attracts capital, and once too much money piles in, the original inefficiency that drove excess returns may disappear. Passive investing and the dominance of flows (Priority: 5/5): They discuss how market-cap-weighted passive flows can overwhelm fundamentals, benefiting mega-cap growth names and weakening the market conditions that historically helped value. Innovation as a secular headwind for value (Priority: 5/5): Drawing on Kai Wu’s work, the episode argues that value may be implicitly short innovation, not just short technology, which could explain persistent underperformance across sectors. Cyclical rebound vs secular deterioration (Priority: 4/5): The hosts conclude that value may still be cheap enough for a near-term cyclical bounce, but its long-term framework may need to evolve to reflect intangibles and innovation.

Key Arguments: Low interest rates raise the present value of growth companies more than value companies because more of growth’s worth is tied to distant future cash flows. When rates are suppressed, investors searching for return move farther out on the risk curve, often toward high-growth stocks. Value historically benefits most coming out of recessions, so fewer recessions may mean fewer periods of strong relative performance. The very simplicity and logic of value investing can become a weakness because it attracts large amounts of capital after the factor is identified. Passive investing may reduce the market’s sensitivity to fundamentals by channeling money into market-cap-weighted indices that overweight large growth names. Innovation, not just sector exposure, may be the deeper reason value has lagged; value tends to own the least innovative companies within sectors. Value’s recent outperformance could reflect expectations for higher inflation and rates, which would be supportive, but that outcome is not guaranteed. Traditional value may look extremely cheap and could still rally sharply, but over long horizons the framework may need to incorporate intangibles and newer business models.

Data Points: Value underperformance period: ~10 years - Jack describes the recent decade as a prolonged period in which value has not worked well. Recent rally in value: Past 6 months - The episode notes a strong recent run in value stocks, especially small-cap value. Follow-up on original article: 2 years ago - Jack revisits and updates his earlier article, “The Case Against Value Stocks.” Passive vs active assets: About equivalent - They note that assets in passive funds may be roughly equal to assets in actively managed funds. Economic cycle pattern: Less recessions than 50 years ago - The hosts cite a long-term decline in recession frequency as a structural change affecting value opportunities. Historical comparison period: Late 1920s to early 1940s - They reference O’Shaughnessy research on a prior era of value underperformance during major innovation. Potential tactical window: 12 to 24 months - Justin suggests the next 12-24 months could be especially important for inflation and rate expectations. Long-horizon horizon used in discussion: Over 100 years - Jack argues that value metrics may need to change over very long time spans because modern firms like Google cannot be valued well with price-to-book.

Pivotal Quotes: "What do you do when you have a period where that strategy doesn't work." — Jack: He frames the core challenge for any investor committed to a long-term factor strategy. "The voting machine has been far more important. Flows have been driving the market far more than fundamentals." — Jack: Used to explain why passive investing and market flows may be distorting traditional value/fundamental relationships. "Over 100 years, I don't want to necessarily continue to use these metrics. I need to change my strategy." — Jack: He explains why value investors may need to adapt their methods to account for intangible assets and modern businesses.

Implications: Listeners should view value as potentially cheap and cyclical, but not automatically destined to outperform structurally. The future likely depends on rates, inflation, market flows, and whether value investing adapts to innovation and intangibles.