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Why You Should Overweight Value Stocks in the Years Ahead

02/28/2013

Aside from selecting good funds, investors need to pay attention to their asset allocation if they wish to earn consistently good returns. By so doing, they decide on which categories and sub-categories of funds/ETFs should be represented in their portfolios and, if included, to what degree. For example, if I decide on a 60% allocation to stocks, should these be half in so-called growth funds and half in funds labeled as value funds or, some other combination? Since there are indeed many sub-categories of funds, how does one choose and does it really make a difference? And once chosen, should your allocations remain fixed at these levels, or are there reasons, other than rebalancing or poor individual fund performance to alter them?

Research has shown that the choice of which categories, or sub-categories, to invest in is the most important determinant of an investor’s portfolio’s above par or sub-par performance. This means it is even more important than which specific funds you include in the portfolio. If so, then the above questions become even more important. So, these decisions should attempt to make use of whatever data might be available to help ensure a favorable outcome.

Overall stock or bond fund or ETF category performance can be typically be observed to run in multi-year cycles of relatively good vs. sub-par performance as compared to long-term average returns. This is also true of the various sub-categories (i.e. growth or value) by which individual securities are frequently organized when they are pooled into funds. Investors willing to use knowledge of prior investment cycles as well as where we seem to be currently in that cycle to periodically adjust their portfolios may be able to achieve significantly better returns by focusing on particular sub-categories within the overall asset classes of stocks and bonds.

In order to do this, one may need to “un-brainwash” oneself from the seemingly popular notion that past performance of investment categories has no relationship with subsequent performance. Such a view essentially espouses that stock prices are nearly, if not totally, unpredictable from year to year. While it is true that one is never guaranteed to succeed by following past trends, we know that asset prices, whether for stocks, bonds, houses, precious metals, or whatever, tend to either rise or fall, not at random from year to year, but over multi-year stretches of either doing well or doing poorly. Then, at some point, the trend reverses, often carrying investment performance in the opposite direction, again often for a number of years.

The problem, though, for most investors is that even within multi-year trends, it is relatively rare to see many years of uninterrupted investment performance in the same direction. Rather, just to confuse things it seems, a rising or falling trend can often take a “break.” The result is that investors who otherwise might have proceeded with confidence now must weigh the chances that the trend has indeed been broken with prices headed in the opposite direction.

We have had a good example of that just recently. After two straight years of excellent yearly performance beginning in 2009, 2011 was a subpar year with the average US stock fund down 2.9%, although the S&P 500 index squeezed out a 2.1% gain.

Many investors could have easily surmised that the then new bull market was likely over. I, on the other hand, did not assume that; I continued to raise my Newsletter’s overall Model Portfolio allocation to stocks for moderate risk investors to 62.5% in Jan. 2012 and 67.5% in Apr. 2012. 2012 turned out to have been another good year with the S&P rising 16%. And, of course, 2013 is off to a good start with the index up over 6% through Feb 27th.

Thus, the multi-year rising trend for stocks which began in early March 2009 will now apparently reach 4 years, rising a total of approximately 130% from that bottom for Large Cap stocks, in spite of taking a long enough break in 2011 to convince some investors that no further bull market gains could be expected.

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