Relative Strength and Value

Numerous academic studies, some archived on our website, suggest that outsized returns can be achieved over time by purchasing cheap stocks with high relative strength.  In fact, James O’Shaughnessy highlighted this in What Works on Wall Street as one of the best strategies over the past 50 years.  Lost in all of the hullabaloo over Apple’s dividend, oil prices, Iran, and so on is the fact that the market is undervalued—and has been for most of the past year, according to Morningstar’s fair value estimates.

Source: Morningstar  (click on image to enlarge)

What I know about valuation methodologies could probably fit on the head of a pin, but that’s what Morningstar’s analysts do all day.  When they look at where stocks are selling relative to their estimates of fair value, the market as a whole—and even most sectors—is still undervalued.

Retail investors have been incredibly reluctant to re-engage with the stock market since being burned in 2008-2009.  For a couple of years now, much more investor money has been flowing to bond funds than stock funds.  I’m just not sure if that is a rational move when stocks are undervalued.

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