Authored by Michael Lebowitz via RealInvestmentAdvice.com,
In our recent article,The Value Rotation Illusion, we explained that in the recent rotation from growth to “value”, passive investors, in actuality, are selling value stocks to buy expensive stocks. Confused? In this follow-up, we take our three-tier earnings valuation framework introduced in the article a step further to uncover true value stocks.
First, though, it’s vital to provide context for why the passive investment landscape skews stock valuations.
A passive investment environment is oftentimes agnostic to valuations, blurring the lines between traditional investment styles like value and growth.
Oftentimes, we associate passive investors with investing in broad market indexes such as the S&P 500 or the Nasdaq. However, passive investors also buy sector- or factor-based ETFs, such as consumer staples ETFs or large-cap growth factor ETFs. The word “passive” means they are not picking individual stocks, but it doesn’t necessarily imply their investment style is passive.A growing number of passive investors are actively trading, rotating in and out of popular narratives and themes. For more on the topic, please read our recent articleCalm Market Waters Hide Fierce Undercurrents.
For instance, over the last few months, stocks in large-value ETFs have been hot, while the once-trendy mega-cap technology stocks have fallen out of favor. We can easily see this rotation in the performance differences between value and growth ETFs and sectors, as well as in the money flows into and out of the largest ETFs.
The first graph below shows the stark contrast in money flows from the Vanguard large-cap value (VTV) and the iShares large-cap growth (IVW) ETFs. The second graph shows a greater divergence between the State Street Energy ETF (XLE) and the State Street Technology ETF (XLK). The data in the graphs is courtesy ofETF.com.
The media is making quite a to-do about the exodus from “expensive” growth stocks into “cheaper” value stocks.Yet as we showed in Part One, investors are chasing a narrative. In many cases, investors are selling value while believing they are buying it.
The value rotation narrative can be summarized as follows: Higher-beta, mega-cap growth stocks have run their course and are now expensive and risky. Therefore, the logical place to rotate to is toward the opposite, less expensive, smaller-cap, and value sectors.
Regardless of whether the narrative makes sense, it is driving the markets, the sectors, and the factors beneath them. Thus, while we can tell you all day that many value ETFs do not represent value, it doesn’t matter. The narrative will trade patterns until it fades.
Source: ZeroHedge News
