Where Value Meets Momentum in Today’s Financial Ecosystem

My background in biology, coupled with an education in evolution, organic chemistry and biochemistry, has challenged conventional investment thinking and shaped my perspective on the investing world.

Much like in chemistry, where reagents may remain inert in the absence of a catalyst to initiate the reaction, contrarian investments too can stagnate without a market catalyst. These investments, similar to unreactive compounds, risk becoming value traps or dead weight within a portfolio, awaiting a pivotal external event or shift in market dynamics to ignite a significant transformation and unlock their inherent value.

In the realm of financial markets, a clear pattern is observable: strategies and investments that underperform are either driven out of the market or greatly diminished in value. This movement of capital from weaker to stronger performers mirrors the principle of natural selection within the investment environment. This principle forms the foundation of momentum investing, a strategy that capitalizes on prevailing market trends. But in biological natural selection, the weak is often eliminated and rare is it that a phoenix rises from the ashes.

The challenge then lies in embracing a contrarian investment stance, which defies current market trends without accurately predicting the timing for a rebound in underperforming investments. This complexity highlights the intricate balancing act investors face, oscillating between momentum (or growth) and contrarian (or value) investment strategies. By striving for a balance, investors aim to reduce risk by diversifying their portfolio across assets that are both in and out of favor, thus ensuring a well-rounded approach to navigating potential market fluctuations.

Recently Barrons[i] noted the following:

"Active funds now have 56% less exposure to value investments than to momentum factors—a 15-year low, according to Subramanian. “Funds looking for cheap stocks based on low price-earnings valuations is at a “max underweight,” she adds. “A brain drain and asset drain, with 40% fewer funds, from active fundamental to passive and private suggest markets may be less efficient and offer more alpha potential.”

Value investing has had its share of false starts. But Subramanian writes that value is historically cheap at a time investors could become more attuned to the price they are paying for stocks.

Over the last decade, roughly 150 active large value funds have gone extinct, Morningstar’s Director of Manager Research Russel Kinnel said via email. That could mean a bigger opportunity for those stockpickers who stuck with value if this turnaround materializes."

Clearly Value ( IWD^[ii]) has underperformed growth ( IWF^[iii]) for what seems like forever.

For those around long enough, Growth (IWF) can be the contrarian investment, after experiencing a long period of underperformance to value (IWD)

But does the recent breakout (See Chart below) from a five-year range for value stocks serve as an indication of a potential catalyst – the canary in the coal mine, maybe too soon to tell but we are keeping our eye on it.

[i] Value Stocks Are Down but Not Out. Get Ready for a Comeback. By Reshma KapadiaUpdated April 01, 2024, 12:51 pm EDT / Original April 01, 2024, 11:56 am EDT https://www.barrons.com/articles/value-stocks-bank-of-america-financials-etfs-dfa41ba4?mod=hp_LEAD_1_B_3

[ii] Ticker IWD represents the iShares Russell 1000 Value ETF, an exchange-traded fund that aims to track the investment results of an index composed of U.S. large- and mid-capitalization value stocks. This ETF seeks to offer investors exposure to value stocks, typically characterized by lower price-to-book ratios and expected growth rates.

[iii]Ticker IWF represents the iShares Russell 1000 Growth ETF, an exchange-traded fund designed to track the performance of an index composed of U.S. large- and mid-capitalization growth stocks. This ETF aims to provide investors with exposure to companies that are expected to experience higher growth rates in terms of earnings, sales, book value, and cash flow.

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About the Author – Dane Czaplicki, CFA®

Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.

Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.

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