I was playing around with Relative Rotation Graphs (RRG) on the weekend with a focus on changes in sector leadership (see my previous post RIP Recession. Reflationary resurrection next?). RRG charts measure how a stock or sector is performing relative to a benchmark on a short and long term basis as a way of better understanding the evolution of market leadership. An idealized rotation cycle would see a stock or sector rotate in a clockwise fashion starting at the lower right quadrant (weakening) to the lower left (lagging) to upper left (improving) and to the top right (leading).
When I turned the lens from sector leadership to market styles, or factors, I got a big surprise.
The chart below tells the story. The low volatility is starting to roll over in relative performance, which is similar to the observation that defensive stock leadership is rolling over. High beta stocks, small caps and momentum stocks are still struggling. The big surprise is the rise of value stocks as the likely new leadership.
Perhaps it is no surprise that even Rob Arnott, the father of “smart beta” advocated a switch from quality stocks to value stocks. He stated that the outperformance of quality was getting stretched, while value stocks were trading at large historical discounts (via Marketwatch):
As a sign of how beaten up the value style is, consider this post which asks “How good is Buffett really?” and this article from Business Insider opining that the legendary value investor is way overrated. Are articles like these signs of capitulation for the value style?
I wrote about the Buffett performance record back in December (see Is Warren Buffett losing his touch). The Berkshire Hathaway return record has been marred by the headwinds posed by the value style. The top panel of the chart below is the relative returns of the Russell 1000 Value Index, which shows how badly the value discipline has performed in the last few years. The bottom chart is the relative return of Berkshire Hathaway B (BRKb) against the market. The relative performance of BRKb has been so-so against the index, but stellar against value stocks.
When I zoom into a shorter term time frame, value stocks have staged a rally out of a relative downtrend and may be in the process of making a relative performance bottom.
For investors and traders, current conditions suggests that value stocks could be a source of superior returns over the next few months, possibly years.