A Simple TruthI have spent a lot of time pouring over why value stocks have underperformed growth stocks in the U.S. over the past decade. In my search to confirm that value investing is still a useful strategy, a simple truth emerged. Value stocks underperformed growth stocks…because they were supposed to. Value stocks are expected to underperform when the stock market has above-average returns.
To smooth out your investment returns, reducing the losses in the bad years, you want to own investments that behave differently. From 1927-2016, value stocks were negatively correlated with the overall stock market. That’s finance speak that says when the stock market produces above-average returns, value stocks are more likely to have below average returns. Thankfully it doesn’t mean value stocks are likely to have negative returns. It just means they are likely to have returns below their average, which is exactly what has happened.
The unexpected part was just how long the good returns have continued in U.S. stocks, causing people to grow tired of their value stocks lagging. Keep in mind that the negative correlation also means that when the stock market has below average returns, value stocks are likely to have above average returns. Many people expect below average returns for U.S. stocks over the next decade. So hold onto those value stocks. You are likely to be happy you did.