Arnott: Value Stocks Priced at or below Depression Levels

Researcher and money manager Rob Arnott has made a lot of headlines lately with his focus on the bond market, but in yesterday’s Financial Times he keyed in on another asset class — and it’s one that he says is extremely cheap right now: deep value stocks.

“Most investors,” writes Arnott, “do not yet realise that today’s spread between growth and value, on most measures, is nearly as wide as it was at the peak of the tech bubble. But this time it is the value stocks that are the extreme outliers.”

In the tech bubble, he says, typical growth stocks were priced at more than three times the valuation multiples of average stocks — the highest growth stock valuations ever. Today, he says, it’s the opposite, with deep value stocks trading at “valuation multiples … near or below Great Depression levels”.

Arnott says some will argue that today’s harsh economic climate has raised bankruptcy risks to such a high level that the growth/value spread is justified, and that deep value stocks won’t outperform growth stocks moving forward. He doesn’t think so, and he says history is on his side. “Over the past 50 years, when the average growth stock was priced at less than a 60 per cent premium to the average stock, growth beat value nearly two-thirds of the time,” writes Arnott. “When the average growth stock was priced at more than 120 per cent premium, growth beat value only twice (1989 and 1999). Today, that spread is 140 per cent. This could be a problem for growth stocks, and a boon for the battered value stocks.”

Arnott says no one knows whether this latest bear market has ended, and he says that a number of concerns remain. But, he says, “It seems likely that, if the bear market is over, the leadership in the recovery is likely to be the much-loathed deep value stocks. If it is not over, it’s hard to imagine that technology can dodge the depression bullet, or that healthcare can maintain lofty profit margins in the face of a political environment that is poised to nationalise healthcare.”

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