Deep Value Stocks Are Super Cheap. Why a Recession Isn’t a Worry.

“A common perception is that value stocks are more cyclical and therefore more vulnerable to economic downturn,” he said in a white paper. “We find that this conventional wisdom is false.”

Value is often associated with economically sensitive “cyclical” stocks—companies that follow the trend of the economy, prospering when it does well and struggling when growth falters.  

It seems intuitive that cyclical stocks would have a hard time in a downturn. If a recession does materialize, that hurts the businesses whose sales and earnings are more sensitive to changes in economic growth.

But Inker looked at the performance of value across a range of recessions from the past 50 years and found no empirical evidence that value stocks consistently underperform during recessions.

“Growth companies are every bit as likely to disappoint in a recession as value companies are, and that means the value companies aren’t uniquely vulnerable in recessions, everybody is vulnerable in recessions,” Inker said in an interview. 

“If we are in a world where a lot of companies are going to be disappointing, that is very likely to be more painful for the growth companies than the value companies because it just hurts more to be a disappointing growth company,” he added. “Value companies have the benefit that nobody expects very much of them.”

So why has the underperformance narrative persisted?

“There is the basic statement that things are cheap for a reason, and it is generally true that a stock that is quite cheap at a given point in time, there is some reason why the market is unhappy with it,” Inker told Barron’s. “But I think what’s happened is people conflate the fact that there is some issue with a company to, well, if we are nearing a recession, or people are worried about a recession, it must of course be the case that the reason why these stocks are cheap, is because they’re very vulnerable in a recession.”

And a recession sooner or later is inevitable, Inker said.  

“There is no chance we have somehow entered into a world where the business cycle is no longer an issue,” he said. “I think it is reasonably likely that we are going to get a recession within the next year or two.”

But investors should focus less on the probabilities of a recession and more on owning stocks that seem to be priced to give a strong return, he said. And right now, Inker sees plenty of opportunities for investors to scoop up so-called deep value stocks—the cheapest 20% of the market.

“The cheapest tier of stocks is trading at just about the largest discount to the market we have ever seen,” he said. “That strikes us as a very good group of stocks to own.”

Value stocks always trade at a discount to the market, but the size of the gap has a large impact on the attractiveness of the group, Inker said. The cheapest 20% of the U.S. market is now less expensive than in 98% of all of months going back to 1970. “The only times it has ever been cheaper were five months at the peak of the [tech] bubble in 2000 and three months in the fall of 2020,” he said.

Based on GMO data, the cheapest 20% of the market normally trades at about a 39% discount to the market, whereas today it is trading at a 53% discount. If that “deep value” group reverted tomorrow to its average valuation discount it would outperform the market by 30%, Inker said.

“Right now, we really like deep value stocks everywhere around the world,” he added. “And that’s been where we have been putting the marginal dollar to work.”

Inker said the firm’s two deep value portfolios—the GMO US Opportunistic Value Fund (ticker:

PPADX

) and the GMO International Opportunistic Value Fund (

GTMIX

)—are biased toward higher-quality value stocks and “trying to make sure we’re not owning companies that are going to be in trouble if we get a recession.”

Write to Lauren Foster at [email protected]