Observation: If something cannot go forever, it won’t. At current performance rates, there will be five stocks comprising 110% of US market cap. That “seems” unlikely.

So, in scanning nearly everything printed in academic finance – and a variety of practitioner productions – here is a general “why” behind the disparity between Growth and Value that we have observed and lamented for these past few years:  (Not necessarily in order of importance)

1. 1. It is well documented that publishing an “anomaly” produces its subsequent demise. The advent of technology applied to massive growth in indexing and derivative strategies has pushed “gazillions” into value factor models that has ruined the traditional value premium.
   2. “Yield” was a historic factor in Value outperformance. A combination of lower dividend payout in general in corporate America, plus less “oomph” in the value of share repurchase at increasingly higher valuations has sapped some of Value’s push.
   3. Price as its own catalyst – valuation spreads become so extreme that they cannot stretch any further – Value is very cheap.
   4. Low or negative real interest rates for an extended period of time – manipulated by the monetary powers that be – have enabled an unusual persistence of high returns on equity/capital in “winner take all”, network effect-dependent markets that produced quasi monopolies: Google, Facebook, Amazon. Glamorous tech earnings misses – were a major contributor in the 4Q18 market pullback – potentially leading to rebalancing to Value.
   5. Low rates and insanely lax credit conditions have enabled zombie firms, many of which are in traditional value industries, to survive longer which thereby depresses returns/margins for remaining players. It has also reduces the costliness of holding lottery ticket like growth companies without true earnings/cashflows.
   6. Economics rebound as quarantine loosens or a COVID-19 vaccine and/or treatment is discovered – Value leads in recovery.
   7. Most indexed money remains market cap weighted, creating a very painful momentum trade favoring Large Cap and/or Growth.
   8. Has Private Equity “stolen” the good Value companies from the public market, leaving an impaired group of survivors?
   9. Stocks in general are not “cheap” by any measure except relative to a 10-year treasury. It is Growth’s valuation that has gone through the roof while the valuation for Value has stayed flat or grudgingly moved somewhat higher.

SO NOW WHAT?  HOW DOES MEAN REVERSION HAPPEN FROM HERE?  IF NOT NOW, WHEN?

1. 1. But perhaps the biggest source of market inefficiency remains the human being. As groups, we repeatedly veer to extremes in our optimism or pessimism, leaving mispriced securities in our wake. And then there are institutions that play by rules imposed by regulation, contract, or internal policy. The result can be actions that make sense for the institution but create inefficiency in the market. In short, many inefficiencies remain.
   2. Said another way – is not the problem the solution? The mess in Value, its “anti-momentum”, is exactly the cure for future outperformance?
   3. The spread between Growth and Value is not just about Value doing better. Part of the reversion will be the end of the craziness in Growth.  Tesla, money losing entities, the end of the free credit?
   4. The election? Last we checked, the party not in power is not a fan of “big business,” and corporate profitability and concentration. And they like lawyers.
   5. At the risk of repeating ourselves…small is beautiful. We at Cove Street Capital are not a monolith asset manager with tens of billions trading companies as quantitative factors. We curate, we focus, and we think that equities are pieces of ownership in real businesses run by real people. Value is not a “class” that is doomed to some Marxian inevitability.