Record Uncertainty Creates Extreme Opportunity

First Quarter 2020 Commentary

This Pzena Investment Management, LLC (“Pzena”)  commentary is a historical document and is intended solely for informational purposes. The views expressed reflect the views of Pzena Investment Management (“PIM”) as of the date published and are subject to change. Neither the writer nor PIM undertake to advise you of any changes in the views expressed therein. There is no guarantee that any projection, forecast, or opinion in this material has been or will be realized. Past performance is not indicative of future results. All investments involve risk, including risk of total loss.

With the absolute impact of the coronavirus still unclear, global equity markets finished the first quarter grappling with the biggest selloff in a generation. Share price volatility reached its most extreme level since the Great Depression. When shares in a single stock move up 10% one day and down 10% the next, it is clear that the market has no idea what to expect. That’s why volatility is such a great proxy for uncertainty. We are in the single-most uncertain market environment since the Great Depression.

Figure 1: Uncertainty has Jumped to Depression-Era Levels

Source: Empirical Research Partners
¹Annualized and equally-weighted data based on the share price moves for the top 1,000 stocks in the US Large-cap universe

The question that virtually every investor is wrestling with is, “What do I do now?” And the answer for many has been to run for the hills, hide out in the traditional safe-havens, such as government debt — or for those that prefer equities, take cover in bond proxies or growth stocks. Simultaneously, investors continued to shed cyclical shares widening the performance and valuation gaps that have gone from meaningful to extreme over the last three years.


The rapid selloff in the first quarter exaggerated the above pattern that has persisted for years:

  • Value sustained one of its worst-ever 21-day periods in March further extending the worst anti-value cycle on record.
  • Valuation dispersion for our developed world universe has reached its widest point on record. (See Figure 2.)
  • Dispersion across all our regional universes are similarly peaking (i.e., 99th- or 100th-percentile) relative to history.
  • In our portfolios, absolute valuations are generally comparable to levels reached during the global financial crisis, and they are discounted significantly compared to where they were at the height of the dot-com bubble.i
Figure 2: Unprecedented Dispersion Across the Globe

Source: Sanford C. Bernstein & Co., Pzena analysis.
Data through March 2020. Dispersion between cheapest and most expensive quintiles based on price to book; equally-weighted data.
Universe is based on the MSCI World Index.

While broad market averages have dropped by 20%–30% from their all-time highs, so many value shares are trading as if their businesses will never recover. As value investors, our research process starts with stocks that have already been deeply discounted. As Figure 3 demonstrates, the share prices in our portfolios have dropped by approximately 50% to 55% from their three-year highs.

Figure 3: The Average Portfolio Holding is Trading at a Deep Discount

Source: FactSet, MSCI, Pzena analysis
All data based on local currency
1 Based on representative portfolios of our Pzena strategies; equally-weighted average data
2 Index-weighted data
Past performance is not indicative of future returns.

These results have been consistent across every one of our major universes. These stocks have declined twice as much as the broad MSCI All Country World Index from its recent all-time high.

So, the looming questions on investors’ minds are, “Will this be a multi-year period of economic malaise? Or is this a relatively short contraction, in which the world will return to normal over the next 12 to 18 months?” If COVID-19 issues get resolved in the shorter timeframe the answer is fairly obvious.


Outside of the extreme example of the Depression era, we wanted to see how value has fared following periods of peak uncertainty. So, we examined returns among our data sets to which we have the longest, most-reliable time series available, US large-capitalization stocks based on the Russell 1000 Index. As shown in Figure 4, buying stocks around peak volatility has been an effective strategy:

Figure 4: Value’s Stronger Recovery from Volatile Periods

Source: Empirical Research Partners, Frank Russell Company, Sanford C. Bernstein & Co., Pzena analysis
1 Calculated using daily return volatility measured over 21-day windows within the largest ~1,000 US stocks ranked by market cap.
2 Cheapest quintile price to book of the largest ~1,000 US stocks ranked by market cap; equally-weighted returns
All returns using monthly data and annualized in US dollars.
This table does not represent any Pzena product or service. Past performance is not indicative of future returns.

On average, simply buying the index during the last eight bouts of volatility has garnered investors a healthy 15.8% return after one year and an annualized 13.3% gain after five years. Value stocks have done even better, averaging a one-year profit of 28.4% and a five-year return of 18.7%, per annum. When the sellers become exhausted in a market rout, the cheapest stocks are difficult to ignore.


In order to better understand what happened after the first volatility spike (in Figure 1), following the stock market crash of 1929, we evaluated the returns of the S&P Composite Index and compared them to value stocks, defined as the cheapest quintile of businesses within the US stock market. This would be similarto this year’s first-quarter results where markets have already declined sharply. The data is shown in Figure 5; index investors that bought into the broad market after the crash would have lost 17.7% over the following year, while the value investors would have fared even worse (-33.7%). However, if each set of investors held their portfolios for five years, those with broad market exposure would have accumulated losses at a rate of 10.8% per annum; the opposite would have been true for the value investors. This group would have actually gained 10.4% on average over the following five years.

Figure 5: Value Investors’ Five-Year Gains After the Crash

Source: Empirical Research Partners, Kenneth R. French, Robert J. Shiller, Pzena analysis
1 Calculated using daily return volatility measured over 21-day windows within the largest ~1,000 US stocks ranked by market cap
2 Robert J. Shiller S&P Composite data
3 Fama-French database – universe returns include stocks within the NYSE, AMEX, and NASDAQ for which there is book equity and market equity data; value stocks include the first quintile of (equal-weighted) stocks formed on a book equity/market equity basis.
All returns using monthly data and annualized in US dollars.
This table does not represent any Pzena product or service. Past performance is not indicative of future returns.

What can be gleaned from all this?

If we are NOT entering an extended depression, the evidence suggests that value stocks stand to realize exceptional returns over the next several years.

If we ARE embarking on another depression, based on the one example during the Great Depression, it would have still made sense for investors to buy value stocks, provided their holding period was long enough. The first of those five years would have been admittedly rough. However, attempting to time the market is a losing strategy.

The likelihood that we are about to embark on a multi-year economic rout similar to the Great Depression should be considered low. Most economists agree that the policies employed in the 1930s exacerbated the problems, and current government policies are likely to be far more constructive.


Can active investors actually achieve a higher return than the indices during periods of stress? We believe the answer is unequivocally, “yes.” Resilient companies with operating flexibility and strong competitive positioning that are financially robust may use a downturn as an opportunity to improve their business models. For investors that can distinguish between companies that have a better chance of making it through unscathed from the ones that can’t, substantial opportunity to outperform exists. Given the sharp drop in valuation for the economically sensitive names, patience combined with careful stock selection should be handsomely rewarded.


i based on a comparison of trailing earnings, book values, and our proprietary measure of price-to-normalized earnings


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