Consider, if you will, the stock market’s big ups and downs lately–especially last week. No, I’m not talking about the way technology stocks cratered, then came roaring back. Rather, I’m talking about “value” investing. Less than a month ago value investing–buying beaten-down stocks that are selling cheaply relative to their profits and asset values–seemed to have about as much life as the passenger pigeon, a species that once numbered in the billions but is now extinct. Value was said to be dead, killed off by the New Economy and its ever-more-pricey technology stocks. But just as market gurus were reading the eulogy over value’s grave, it popped out of the ground, caught up to the broad market and is alive and well. At least for now.
Value investing, like pornography, is one of those things that you know when you see, but is hard to define. It holds that the way to make money in the stock market is to buy stocks that are out of favor and cheap, then wait for them to come into favor. Growth investing is the yang to value’s yin. Growth, in its purest form, holds that you can’t go wrong buying stocks of rapidly growing companies, no matter how high their prices relative to profits and asset values. The stocks that have been out of favor and therefore cheap lately are those boring old-line industrial companies–so-called cyclicals like food companies, chemical makers and heavy manufacturers. The glamorous growth companies, of course, have been the high techies.
In practice, though, the line separating growth from value stocks is a little arbitrary, to say the least. For instance, the S<&>P/Barra growth-stock index includes slow-growers like Campbell Soup, Hershey Foods and Times Mirror, and the value index includes 3Com, Advanced Micro Devices and Apple Computer. But, statistical quirks notwithstanding, growth has been trouncing value in recent years. Last year the growth index produced a 42 percent return, including capital gains and reinvested dividends–almost 30 points better than the value index, the greatest difference ever. And growth trounced value in the first quarter of this year, too, 6.9 to 2.6.
So by the beginning of April, the reputation of value investing had started to look as beaten down as the stocks that value investors favor. Billions of dollars fled value-investing funds like Mutual Series and Vanguard Windsor. Windsor, which closed to new investors in 1989 and used to be one of the most-coveted funds on the planet, had an especially awful year, earning all of 0.8 percent in capital gains and reinvested dividends, 28 points less than Vanguard’s S<&>P 500 index fund, which mimics the S<&>P rather than trying to beat it. (Note: The sufferers include many of us at NEWSWEEK, because Windsor is in our 401[k] fund.) On March 25, in a major public diss to Windsor fund manager Charles Freeman, Vanguard announced that effective June 1, it will turn over some of Windsor’s stock portfolio to another firm. (The amount wasn’t announced, but it’s 25 percent.) So what happens? Since March 24, the day before the announcement, Windsor’s return for the year has moved from 1.6 points below the S<&>P to 4.1 ahead as of Friday, a move matched by many other value funds. Money managers generally use the 500-stock S<&>P as a benchmark, rather than the Dow Jones industrial average, which includes only 30 stocks.
The sudden turnaround at Windsor “shows the difficulty of knowing what to do,” says Vanguard spokesman Brian Mattes. Referring to Freeman, who’s run the fund since legendary manager John Neff retired in 1996, Mattes quips, “Chuck has been chanting ‘I told you so’ so much that I think his tongue hurts.” Freeman says he hasn’t been gloating, but he’s sure been feeling a lot better. “We know we had a good portfolio, and it’s good to see it validated,” he says. The bulk of the move came from April 9 through April 19, a period of seven trading days in which Freeman says Windsor gained 12.8 points relative to the S<&>P, a huge move for such a short period. “I’ve never seen anything like it,” says Freeman, 55, who’s been in the money management business for 30 years. “We went from the back of the pack to No. 1 among the 25 largest funds.”
Another big reversal this year has been the Dow industrials versus the S<&>P 500. Last year the folks at S<&>P were taking victory laps when the 500 outperformed the Dow by 10.6 points, 26.7 percent compared with 16.1, for the second-biggest gap since head-to-head competition started in 1922. For 1997-98, the S<&>P was 19 points ahead. But this year, the Dow has thrashed the S<&>P, up 16.4 percent compared with the S<&>P’s 10.4. The major difference: Technology stocks are weighted far more heavily in the S<&>P than in the Dow, which contains a lot of those old-line industrial companies that have been sparking the value rebound. And there’s some plain freakishness, too. Last Thursday, for instance, the Dow rose 146 points, or 1.4 percent, while the S<&>P rose 1.7 percent. But 105 of the Dow points came from just one stock, IBM, which rose 22c. Had IBM split its stock 2-for-1 on Wednesday and risen by the same percentage, the move would have been only 11 5/16 points. That would have moved the Dow only about 53 points.
It’s far too early to say whether the value stocks’ rebound is permanent or what market types call a dead-cat bounce. Chuck Freeman says that even if value is back to stay, “it will move two steps forward and one step back” rather than just plowing straight ahead. Generally speaking, value stocks are more dependent on economic conditions outside the United States than growth stocks are. And it remains to be seen whether the signs of worldwide recovery that some people see are illusory, or whether they’re the real deal. For the growthsters, there’s the question–which will be answered next year–of how much heavy spending to make computers Y2K-compliant has inflated tech stocks’ profits this year. And whether that growth can be sustained next year, when Y2K spending will have tapered off.
Tech-stock prices have been enormously volatile lately, both because the future is somewhat unclear, and because tech stock prices are so high, relative to profits, that there’s little room for error, real or imagined. Many of these stocks are driven by emotion and online traders staring at computer screens trying to divine short-term price trends. The valuations have little or nothing to do with the companies’ actual operations. You can make–or lose–a ton of money overnight with these babies. It’s not classic investing, but it’s certainly a lot of fun to watch.
Meanwhile, the Windsor Fund’s Chuck Freeman is out there plugging away. His portfolio, he says, it selling at about 17 times next year’s projected profits. That would be about 40 percent below the S<&>P 500, which is selling for about 27 times projected profits, according to Chuck Hill of First Call. In a market like this, in which Freeman gained almost 13 points against the S<&>P in seven trading days then gave up three of them in the last four days of last week, who knows what comes next? Despite last week’s hiccups, technology stocks are still driving the market, and many Internet stocks are still selling at valuations that, in hindsight, will be seen to have been utterly insane. So when will tech and Internet stocks finally take their long-awaited tumble? If history–and value investing’s trajectory–offer any guide, it will probably happen the day after the last skeptic throws in the towel.
