Deep-Value ETF Report: Commodities/Energy Remain Out Of Favor

Ben Graham famously described Mr. Market’s psychological state from day to day as vulnerable to erratic swings of optimism and pessimism. But recent history shows that the crowd’s exhibited a mostly stable view on commodities and energy by consistently discounting these assets by relatively aggressive standards, based on a set of exchange-traded products. That was true in our last update (Aug. 22, 2019) and remains so today.

As outlined below, sentiment has been tepid at best when it comes to raw materials and the companies engaged in processing oil, gas and other basic commodities. There are a handful of notable exceptions – gold, for instance, has been trending up in recent years. But across the broad sweep of commodities and energy, investors have cooled to the idea that assets in this corner deserve relatively high valuations.

Before we get into the details, a quick refresher on the ranking system used below. The metric of choice for “deep value” in this column is the 5-year return, which is based on an idea outlined in a paper by AQR Capital Management’s Cliff Asness and two co-authors:  “Value and Momentum Everywhere,” published in a 2013 issue of the Journal of Finance. There are many value metrics and so no one should confuse the 5-year-performance benchmark as the definitive measure of bargain-priced assets. But as a starting point on the journey of identifying where the market’s outlook has fallen sharply, the 5-year change is a practical measure.

One advantage of us a 5-year performance measure: It can be applied over a broad set of assets, thereby dispensing a level playing field for evaluating value. Another plus: this metric is simple and therefore immune to estimation risk, which can complicate accounting-based value gauges, such as price-to-book and price-to-earnings measures. In short, the 5-year return is a handy tool as a first approximation for identifying ETFs that may be deeply discounted by the crowd — and thereby offer (possibly) relatively high expected returns via the value proposition for investing.

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