In his latest article for Canada’s Globe and Mail, Validea CEO John Reese discusses the role that expectations have in the stock market, and in the tendency for value stocks to outperform flashier growth plays.
Comparing hot growth stocks to big summer blockbuster movies, Reese writes, “If you’re like me, you’ve probably had the experience of going to one of these overhyped movies and walking away less than thrilled. The movie might not have been bad — in fact, it might have been quite good. But once the buzz surrounding a film reaches a certain level, it’s hard to live up to the hype.”
The same is true in the stock market, Reese says. Hot growth stocks often have such high expectations baked into their share prices, that results that are good but not great can send their stocks tumbling. So little is expected from beaten-down value plays, however, that even small improvements in business can lead to solid stock gains.
Reese looks at how several of the investing greats upon whom he bases his “Guru Strategies” — including Joel Greenblatt, David Dreman, and Benjamin Graham — realized the impact expectations had on stocks, and used that to their benefit in building value-focused portfolios that outperformed the market. He also discusses how current fears hovering over the stock market — including the Eurozone debt woes, the Japan disaster, and the end of the Federal Reserve’s latest round of quantitative easing — are keeping expectations down for stocks in general. “All of those issues are legitimate and must be dealt with,” he says. “But while these problems inspire fear, they also lower expectations for many quality companies – and investors’ tendency to be myopic often leads those expectations to become unrealistically low. For disciplined investors, that signals opportunity.”