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May 31, 2002

The New Search for Value

By Kathryn M. Welling

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Wow. Could value investing have had a more dramatic reversal of fortune? It was in mid-November 1999 that an earlier version of the chart over yonder first graced these pages. In other words, only about three months in advance (but only half-way there, in percentage terms) of the point of maximum pain for true believers in the value style of investing occasioned by the late, great tech bubble.

Prominent among that then-dwindling band of tech adherents you could (then and now) count the estimable Philadelphia-based money management firm of Aronson + Partners, whose handiwork the chart is.

Positive Territory

Back then, as Kevin Johnson, Aronson's research director, cheerfully admitted that what he called-with thanks to financial writer Jason Zweig, who coined the term-his "" chart was terrifically self-serving, implying, as it did, that sooner or later value would out. Yet value most decidedly has burst back into positive territory, going almost perpendicular in climbing out of that ravine the raging new era bulls had dug on the Aronson chart. [Because the folks at Aronson are (shudder) quants they describe the exercise that produced the logarithmic chart are "simple."

But what it actually illustrates is the return on a paper portfolio constructed by going long the cheapest decile, and shorting the richest decile, based on trailing 12-month earnings, going back practically to the dark ages-on a quarterly basis, between March 1962 and March1980, and monthly since then.]

Indeed, the rebound has created the most dramatic and virtually straight up move on the entire 40-year chart. Fittingly, perhaps, after the steepest plunge, 53 percent, over the 21 months between May '98 and February '00, the value portfolio has roared back up an incredible 239 percent since the frenzy died in early March, 2000. Which frankly is cause for at least a little concern. And clearly why all you have to do these days is scratch any random value investor on the Street to hear laments about how hard they have to work to find stocks worth buying.

So I called Philly to see if Kevin Johnson and the rest of the Aronson crew share my misgivings. Yes-and no-came Kevin's answer. "Yes, the rebound has been very crazy. But by our lights, it's only sort of back on what we consider to be trend." In other words, Kevin reiterated, even with all the obligatory caveats about how the little paper exercise

represented by the chart doesn't involve transaction costs and all that nonsense, "we really do think the value portfolio strategy works."

Besides, he added, "there's nothing that says that it can't overshoot. Just imagine, having seen how much it undershot, imagine it were to overshoot that much on the opposite side. In other words, if you think value's performance is anywhere near back on its long-term uptrend line, imagine if it bounced-depending on how large you print the chart-call it another inch and a half over the that trend line. That would take it up another whole bunch of percent."