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The Dow’s Underperformance Is Bringing Value Investing Back

Last Updated September 23, 2020 1:58 PM
Laura Hoy
Last Updated September 23, 2020 1:58 PM
  • The Dow has vastly underperformed the NASDAQ and S&P 500.
  • For investors who believe a “new normal” is coming, the Dow is antiquated.
  • If you think the economy will return to normal, the Dow’s underperformance suggests it’s time to pick value stocks.

Over the past few weeks, the stock market has pulled off an impressive recovery despite gloomy economic predictions. But while the Nasdaq has managed to rise 1.1% over the past three months, the Dow Jones Industrial Average is down nearly 13%.

Some say the disparity underscores how antiquated the Dow has become; viewed from another angle, it offers investors some sage investment advice.

Dow Misses the Recovery

The dow, stock market, value stocks to buy
The Dow has lagged the broader market. | Source: Yahoo Finance

A big reason why the Dow isn’t recovering at the same rate as other indexes is that it doesn’t include the FANGs.

The way the Dow is weighted means mega-caps like Amazon (NASDAQ:AMZN) can’t be included. That underscores the fact that only a handful of stocks are propping up this stock market rally. More importantly, it highlights the parts of the U.S. economy that can’t thrive in a world stuck with social distancing.

Dow Stocks Signal Return to Normal

If pandemics, social distancing, and lockdowns are the future, then the Dow is indeed an antiquated index. But if you believe the economy will eventually return to “normal,” the Dow is where you want to look for investment ideas.

Boeing, stock market, value investing
Boeing is one example of a Dow stock left out of the recovery. | Source: Yahoo Finance 

Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL), Amazon, and Netflix (NASDAQ:NFLX) are all stocks that will thrive in a world that lacks social contact. Meanwhile, some of the Dow’s stalwarts like Boeing (NYSE:BA) stand to perish if people don’t eventually start traveling again. A bet against the market is a bet on a return to normal.

Value Stocks Are Good Bets Now

That brings to mind the prospect of value investing–something investors have all but abandoned in this momentum-fueled rally. Value investing is something Warren Buffett popularized, and value investors seek out undervalued companies that stand to gain in the future.

SEI Investments’ James Solloway says they’re about to come back in fashion :

There are periods where leadership changes in a drastic and dramatic fashion and they usually correspond with the bottoms, or the near-bottoms, of a recession following a period of accelerated deterioration in those asset classes. And that is precisely what we have seen this year with small caps, value stocks, and emerging markets

value stocks, stock market, the dow
It could be time to start betting on value stocks as they offer a compelling investment choice right now. | Source: MarketWatch 

Salloway believes that a potential second virus outbreak will be met with resilience this time as most countries are better prepared to deal with the influx of new patients. With that in mind, he thinks it’s time to start looking to underappreciated sectors rather than stay-at-home stocks:

I do believe that when all is said and done, we are not going to have as bad a second reaction to another wave as the first one, and if that’s the case, then I think that provides the fundamental rationale for investors to seek out the most bombed-out sectors of the stock market as they usually do.

Where’s the Value?

So, where’s the value in today’s market? There are a ton of places to look both inside and outside the Dow Jones. But the pros say the best value stocks to buy are those that have encountered temporary stumbling blocks that will improve as the economy reopens.

Warren Buffett’s investment firm Berkshire Hathaway (NYSE: BRK) is one such underappreciated equity. Fund manager Bruce Berkowitz has been buying up thousands of shares  throughout the first quarter, and famed investor Bill Ackman also scooped up shares in recent weeks.

value stocks, the dow, stock market
Betting on value stocks for the long-term could offer the best returns right now. | Source: MarketWatch 

Other value plays worth a look , according to Mark Hulbert’s Hulbert Financial Digest, include Walt Disney (NYSE:DIS), FedEx (NYSE:FDX), and International Business Machines (NYSE: IBM).

Investors with a stronger stomach might want to look into the beaten-down airline sector to pick up strong players like Southwest (NYSE:LUV). 

Disclaimer: The article represents the author’s opinion and should not be considered investment advice from CCN.com. The author holds no investment position in the above-mentioned securities.