The basis of value outperformance vs. growth over history is simply that while growth companies do indeed have faster earnings growth, the margin of extra growth is less than embedded in their price, and the subsequent price adjustments leads to value outperforming in the long run.
In the two-year period of extreme value underperformance prior to the onset of COVID-19 for which we can get meaningful earnings data, the normal earnings patterns hold true. Indeed, value companies did better relative to growth companies than normal.
Pricing was so extreme that at the start of 2020, the prices of growth companies had around three times the sensitivity to deteriorations in margin or earnings growth, and five times the sensitivity to increases in leverage. Thus, an unexpected growth shock should have produced a much greater impact on growth companies.
Instead, we then had a completely irrational phase as investors panicked in reaction to COVID-19, where quality became a negative attribute and value assumed a beta of close to one, which are collectively a complete contrast from normal behaviors.
Robust analysis of all the various theories put out to justify this, such as it being down to sector effects or a small number of large winners suffers from one slight flaw. It’s just not borne out by the facts when we dig into relative prices.
We have seen some sharp reversion to value this quarter, but only partial to the falls that preceded it. Our best estimate would be that we are still at levels of mispricing on a par with those at the end of the Tech Bubble or the Global Financial Crisis (GFC).