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I’d like to hope so! But let’s take a look at some of the reasons people have given for small value underperforming: low interest rates, low inflation, tons of dumb money sloshing around the markets, value factors having been arbitraged away, the boom in cap-weighted index funds. In the post-vaccine regime, will any of those be different?
[/quote]Who are these people? Where were these people a few years ago predicting large cap outperformance? Why should (1) low interest benefit large growth (that don’t need to borrow) more than small value (which need to borrow). Why should low inflation (2) help lg? Dumb money (3) chases past performance, but why was past performance of large growth so good? When will the dumb money chase small value? If value factors have been arbitaged away (4), how does that explain the factor reversal of value factors (where higher ranks made progressively lower returns), shouldn’t arbitrage make the ranking system backtest flat? How did the boom in index funds (5) create a bubble?
I consider people who have predicted all this in advance more credible than those who try to make sense of what happened after the fact and try to push a narrative. Ken Fisher is on record as predicting large growth outperformance a few years ago. He nailed it.
Largely because of Ken’s influence, I predicted long term large cap outperformace back in 2012 (not because he called it then, but I applied his principles). You don’t find me making too many market calls because there is high uncertainty, so when I do make a prediction I like to be right. I predicted the bottom in Spring 2009 back in November of 2008, and again I confirmed it in 2009 the day after it happened. I called for large cap performance back in 2012, and I called the bottom in 2018 the day after it happened. Unfortunately, I didn’t call the 2011, 2018, or 2020 tops, and my clients took a hit. I have had more success calling bottoms.
Here is my 2020 prediction. Small value, and in particular Asian small cap value, is highly likely to rebound much faster than large caps once this market bottoms.
Why?
My theory is that two factors drive relative performance: (1) fundamentals and (2) momentum.
(1) Fundamentals come in two flavors (1a) risk and (1b) reward. Fundamentals risk (1a) is the business quality. It includes factors such as growth, financial strength, ROE, etc. Reward (1b) is valuation; as defined by the price paid vs. the future cash flow of the business.
(2) Momentum (i.e. “dumb money”) also comes in two flavors, past risk 2a, (volatility) and past reward (2b).
Why did I call it in 2012? Why am I calling it now?
In 2012, valuations (1b) and business quality (1b) favored large caps, but past performance (2) still favored small value. Starting about 2014, the favorable large growth fundamentals started propelling large growth ahead of small value. Once the market volatility in 2011, 2015, and 2018 exposed more price volatility in small value over large growth, large growth looked favorably from a past risk (2a) point of view, and finally from a past reward (2b) point of view. At that point large growth had all four factors going for it.
Then, in 2018, the new tax laws boosted earnings of large growth (think repatriating foreign earnings). Enter the “dumb money” in 2019 chasing large growth and propelling large growth past small value and beyond reasonable valuations. Now, in 2020, the very real risk of bankruptcy to many small caps is pushing valuations of small value even further down. Once analysts are able to quantify the bankruptcy risk of various stocks, I expect small cap value to bounce back in a big way. In particular, small cap value in countries such as Korea, Singapore, and Japan that started with lower valuations and are coping relatively well with COVID-19 have the best fundamentals (1a and 1b) right now, and should start to see past outperformance which will attract 2, dumb money (i.e. past performance chasers).
I really really really would like to see international data be implemented in time to ride the current regime of Asian stocks!