The Value-Cycle
(deutsche Version)

Nobel laureate Fama and his colleague French demonstrated the existence of a value premium in the US stock market as early as 1992. During the period from 1962 to 1989, they found that companies with high ratios of book value of common equity to market value (cheap/ value stocks) generated higher returns than their counterparts with low ratios of book value of common equity to market value (expensive/ growth stocks).1 The historical existence of the value premium has been confirmed by numerous other researchers studying different time frames and regions, and is widely accepted today.2 Even though the value premium was considerably positive in the long-run, it was not stable over time, and temporarily even became negative. The value premium's variability over time is known as the Value Cycle, and has significant influence on the returns of most value-investors.

Historical Value-Premia: Rolling Time Periods (p.a.)
Number of years for the calculation of the rolling value-premia (p.a.):

The upper chart displays the yearly performances of a portfolio that is long in value stocks and short in growth stocks over a time period of 5 years. For instance, a value of +5% means that value stocks outperformed growth stocks by 5% per year over 5 years. The bottom chart shows the absolute development of the portfolio. Own compilation based on the HML-factor from the Kenneth R. French - Data Library ( Data status: .

As demonstrated in the chart above, the Value Cycle may be illustrated using the "High Minus Low" HML-Factor of the Fama-French three-factor model.3 To calculate the HML-factor, Fama and French subtract the average return of two growth-portfolios with low book-to-market ratios from the average return of two value-portfolios with high book-to-market ratios.

The existence of the Value Cycle is evident: Periods of value-underperformances were always finite, and consistently followed by periods of value-outperformances. Clearly, the opposite holds as well: periods of significant value-outperformances (between 2000 and 2007, for instance) were invariably followed by weaker phases. Our capital market research has confirmed these results (only available in German!).

Current Situation and Outlook

We are currently experiencing a pronounced period of value-underperformance that began in early 2007. On the basis of the HML-factor presented above, one can show that this has happened fewer than ten times in the last 90 years (US market). All of these periods were followed by partially large value outperformances. Between 2000 and 2005, for instance, value stocks outperformed growth stocks by more than 140%.

Current Value Premia in Different Regions (p.a.)

If almost 90 years of stock market data is representative of the future, it may be argued that now is an opportune point in time to invest in value-stocks. Clearly, the information presented here is insufficient to predict the exact date that the value weakness will end. However, the fact that periods of value-underperformances were always followed by value-outperformances may play a role in long-term strategic asset allocation.

1Since a high degree of leverage is often a distress indicator for firms in the financial sector, Fama and French (1992) limit their sample to non-financials (see p. 429).

2Capaul, Rowley, und Sharpe (1993), Strong und Xu (1997), Arshanapalli, Coggin, Doukas (1998), Davis (1994), Lakonishok, Shleifer, Vishny (1994), O'Shaughnessy (2012).

3Fama and French originally developed the model in 1993 (refer to list of references).

List of References

Arshanapalli, Bala / Coggin, Daniel T. / Doukas, John, Multifactor Asset Pricing Analysis of International Value Investment Strategies, Journal of Portfolio Management, 1998.

Capaul, C., Rowley, I., und Sharpe, W. (1993). International value and growth stock returns. Financial Analysts Journal, 49, 27-36.

Davis, James L., The Cross-Section of Realized Stock Returns: The Pre-COMPUSTAT Evidence, Journal of Finance 49, 5, 1994.

Fama, E., French, K. (1992). The Cross-Section of Expected Stock Returns. Journal of Finance, 47 (2), 427–465.

Fama, E., French, K. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, 33(1), 3–56.

Lakonishok, Josef / Shleifer, Andrei / Vishny, Robert W., Contrarian Investment, Extrapolation, and Risk, Journal of Finance 49, 1994.

O’Shaughnessy, James P., What Works on Wall-Street, Mc GrawHill 2012, 4. Auflage.

Strong, N., Xu, X. (1997). Explaining the cross-section of UK expected stock returns. British Accounting Review 29, 1–24.

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