Haim Mozes and John Launny Steffens, authors of the study “Getting More Value Out of the Value Factor,” which was published in The Journal of Investing’s Winter 2015 issue, have attempted to create a model that can accurately predict the performance of the value premium.
The factors in their model include analysts’ long-term earnings growth forecasts, overall equity valuations and volatility. They found that value stocks tend to outperform growth stocks when: equity markets are performing well (although this certainly wasn’t the case during the late 1990s); analysts are more optimistic about long-term earnings growth; volatility is low; and when equity valuations are expensive (as they were in March 2000).
None of these findings should come as a surprise, especially if you believe in a risk-based explanation for the value premium. The authors also note that it is difficult to forecast the return to the value premium as well as its correlation to equity returns (which is time-varying and averages slightly above zero).
Following are some of their other findings:
- From 1930 through 1989, the value premium was 0.47% per month, with a much higher standard deviation of 3.72% per month. From 1990 through June 2013, the premium was about half the size of the previous period, at 0.24% per month, with a standard deviation of 3.18% per month. (Note that because returns are roughly linear in time, while the standard deviation increases with the square root of time, volatility will not be as large relative to the premium when looked at on an annual time scale. Thus, the monthly time frame makes volatility look particularly large relative to the size of the premium.)
- The value premium exhibits very high kurtosis (5.13). Kurtosis measures how fat the tails are in the distribution.
- The value premium was positive in just 55% of months. It was greater than 5% in about 6% of months. It was smaller than -1% in close to 30% of months. It was smaller than -5% in about 4% of months.
- Excluding months where the value premium exceeded 5%, the average monthly return turns negative, at -0.16% per month. Thus, more than 100% of the value premium is earned in just 6% of months. On the other hand, if you could have avoided the months when the value premium was worse than -5%, the value premium jumps to 0.7% per month.