A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

Will a vaccine cure the 20-year “Widow-Maker” trade?

In 1999, a media personality stated that “investing like Warren Buffett was like driving dad’s old Pontiac.” Of course, that was at the height of the Dot.com bubble, and soon after, “value investing” paid off. Unfortunately, it didn’t stick.

The Widow-Maker Trade

It wasn’t just 1999. In 2007, individuals were chasing the “momentum” in the real estate market. Individuals left their jobs to pursue riches in housing. They were willing to “pay any price” under the assumption they would be able to sell higher. Of course, it was not long after Ben Bernanke uttered the words “the subprime market is contained,” the dreams of riches evaporated like a “morning mist.” 

In 2020, investors are again chasing “growth at any price” and rationalizing overpaying for growth. As I discussed in the “Death Of Fundamentals:”

“Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”

Chart updated as of November 2020

Vaccine Cure Widow-Maker, A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

Given the massive government and Federal Reserve interventions over the last decade, it should be of no surprise that “growth” has outperformed. For “value investors,” it has been a “decade of pain.” The rise of passive indexing, algorithmic trading, and massive amounts of liquidity have destroyed price discovery in the markets. 

 

Reasons For Under-Performance

In a recent discussion on “Value Is Dead,” we referenced a Research Affiliates article that noted the under-performance reasons.

An investment strategy, style, or factor can suffer a period of underperformance for many reasons.

  • First, the style may have been a product of data mining, only working during its backtest because of overfitting. 
  • Second, structural changes in the market could render the factor newly irrelevant. 
  • Third, the trade can get crowded, leading to distorted prices and low or negative expected returns. 
  • Fourth, recent performance may disappoint because the style or factor is becoming cheaper as it plumbs new lows in relative valuation. 
  • Finally, flagging performance might be a result of a left-tail outlier or pure bad luck. 

If the first three reasons imply the style no longer works, and will not likely benefit investors in the future, the last two reasons have no such implications.

With today’s value vs. growth valuation gap at an extreme (the 100th percentile of historical relative valuations), it sets the stage for a potentially historic outperformance of value relative to growth over the coming decade.”

The underperformance is quite stunning. The chart shows the difference in the performance of the “value vs growth” index. The index compares the pure value to a pure growth index, with each based on a $100 investment. While value investing always provides consistent returns, there are times when growth outperforms value. The periods when “value investing” has the most significant outperformance, as noted by the “blue shaded” areas, are notable.

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