Value sunk by low rates, short-circuited by tech

Benchmarks of value investing have been lagging broader market indexes — and it may be due to two unusual factors

Value sunk by low rates, short-circuited by tech

As value investing continues to disappoint, one must wonder why the style favoured so heavily by Warren Buffett himself has failed so badly in recent years. Two factors are appealing as an explanation: cheap debt and fast tech.

“Low interest rates have lowered the cost of capital dramatically, while new technology has allowed for instant scaling among already-established networks,” said Martin Pelletier of TriVest Wealth Counsel in a column for The Financial Post.

Fast-growing tech sectors, Pelletier explained, are now able to run their businesses at a loss as long as they can access inexpensive capital to fund the rapid growth of their recurring revenues. That has contributed to the large-scale evaporation of the moats and competitive advantage that traditional brick-and-mortar businesses have historically enjoyed.

“For example, Americans spent more on Airbnb last year than they did at all of Hilton’s properties, astounding when one considers that Airbnb does not own a single hotel while Hilton has a portfolio of 5,757 properties in 113 countries,” he said.

A comparison of two major indices shows how tech dominates. Citing S&P Dow Jones Indices senior analyst Howard Silverblatt, Pelletier said the top 10 companies in the S&P 500 accounted for nearly a third of its move from 2,000 in August 2014 to the record close exceeding 3,000 on Friday; the top four contributors, accounting for more than 21% of the index’s move, were Microsoft, Amazon, Apple, and Facebook.

“Compare this to the S&P/TSX, where the top four companies in the index are the Royal Bank of Canada, Toronto-Dominion Bank, Enbridge and Canadian National Railway,” he said. “Consider this: we are the only country in the world whose largest publicly traded company is a bank.”

A more specific look reveals that the Dow Jones Canada Select Value Index has underperformed the S&P/TSX by 6.1% in the past year, and an annualized 1.7% over the past five years. Similarly, the S&P 5000 Value Index has lagged the S&P 500 by over 10% over the past 12 months and an annualized three per cent in the past five years.

“Global value stocks as represented by the Morningstar Developed Markets ex-North America Target Value Index have underperformed the MSCI EAFE by 10.3 per cent over the past year and approximately half a per cent annually over the past five years,” Pelletier added.

Writing in the Wall Street Journal, columnist James Mackintosh pointed to one other period in American history when technology disrupted the stock market: during the 1920s and 1930s, a period that conjures up images of the 1929 stock-market crash. “Chris Meredith at Stamford, Conn.-based O’Shaughnessy Asset Management points out it was also the period when the automobile shifted from early takeup to widespread deployment, bringing mass production and distribution of consumer goods,” Mackintosh said.

In the period from 1926 until the Second World War, he said, cheap value portfolios were stuffed with utility companies that had become mature and dull after leading the electrification revolution. Growth stocks, meanwhile, were embodied by manufacturers that were mostly too expensive for value buyers.

“There’s a similar industry bias today: value has heavy exposure to banks and other financial stocks, which helped it outperform before the crisis but dragged it down since,” Mackintosh said. “This time, the go-go growth stocks are mostly in the technology sector (although Amazon is a retailer), where value has little exposure.”


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