A Different Kind of Rally

by Murray Coleman

(Editor's note: The following is the first of a two-part series analyzing performance characteristics of U.S. stock markets by style and size during the current three-month rally. The final installment "Does Size Trump Style?" can be found here.)

Heading into the second half of 2009, growth is clearly king in terms of stock styles.

But it's facing a strong resurgence by value-oriented investors. Emboldened by depression-like prices just a few months ago, bargain bin shoppers are watching their favorite names score super-sized returns as economic fortunes improve and credit markets revive.

In the ongoing rally that began on March 9 and set a new high-water mark for the year on June 1, the large-cap-dominated Russell 1000 index series, as well as the small-cap-focused Russell 2000 indexes, have shown strong performance slants toward value.

When monitoring the 1000 Value vs. the 1000 Growth benchmarks during the latest rebound, the former has a better-than-7-percentage-point advantage. The Russell 2000 Value Index has about a 3-percentage-point cushion. (See table below.)

But contrast those results to year-to-date benchmark returns through June 1:

• In small-caps, the Russell 2000 Growth has returned 15.76% versus 2.49% for the Russell 2000 Value, or a 13.27-percentage-point pad for growth.

• In large-caps, the Russell 1000 Growth has gained 15.28% versus 1.76% for the Russell 1000 Value, or a 13.52-percentage-point advantage for growth.

The rally, now at 12 weeks, has been strong for both types of style benchmarks, and regardless of size. But it clearly hasn't been enough to erase the damage from a recession that lasted more than 19 months. So the question facing investors as the second half of 2009 unfolds is whether value's run will continue.

In a very general sense, valuations seem to remain reasonable in many key sectors. That would seem to bode well for a continuing surge of interest in value names and sectors. In order for investors to assume more risk, however, much will depend on perceptions of the economy's overall health. If conditions keep normalizing, then long-term historic return patterns suggest that value stocks of all sizes should rebound.

Although value has led growth in this rally, growth has lost less in the past 12 months. That's quite a reversal from the recession of 2000-2002. But notice that gap was miniscule in small-caps while large-caps have enjoyed nearly a 5.4-percentage-point outperformance. It makes sense, given that blue chips are more diversified and less susceptible to the ravages of illiquid credit markets.

Taking a longer-term perspective using the Russell indexing series as a proxy for the overall U.S. marketplace, growth's advantage has proven to be fleeting. In the past 10- and 15-year rolling periods through June 1, value stocks have taken the upper hand... sometimes significantly.

This Rally Is Different

The following table shows how small-cap value stocks did from March 9 through June 1. The sector weightings are rounded and apply to the last day of the period studied.

Click to enlarge

The top-performing sector in both indexes during the rally has been energy. The difference between which names are considered value and growth, however, is creating quite a gap in returns. Russell separates the styles by price-to-book ratios and growth rates; those with lower values go to the 2000 Value Index, while stocks with higher valuations go to the growth benchmark.

But both feature relatively low turnover rates. That means an overwhelming majority of the names now in each benchmark were there a year ago. When those same stocks were taking a brutal beating last year, the relative outperformance in growth has likewise given greater upside to value names in a rally.

The same outperformance by small-cap value names holds true for health care, technology, consumer discretionary, producer durables and financial services. Ironically, counting energy, those are the six biggest sectors in the growth benchmark and account for almost 90% of its holdings.

In fact, only the three smallest sectors in the Russell 2000 Growth Index are outperforming those same segments in their sister value benchmark.

Unfortunately for small-cap value investors, the edge by financial services hasn't been stable. Last week before the big breakout session on June 1, stocks in that sector of the Russell 2000 Growth Index were slightly ahead.

Conversely, other bedrocks of traditional value indexes have been under-performing their lower-weighted growth cousins. Traditional areas of strength in value investing such as materials and utilities are all doing better on the small-cap growth side in the past three months. (See a more in-depth review in the second part of this series.)

So while value-style stocks are leading growth in small-caps, that cushion isn't coming from traditional bastions of value investing.

Rather, small-cap value benchmarks are showing more resilience these days as a result of holding at least some growth. In other words, diversification is proving quite beneficial during this market cycle as indicated by the Russell small-cap style indexes.

[Coming in Part Two: A closer look at large-cap stock performances in this current rally.]

Original Post

Comments

[Maxe Paul:]

"This time it's different", ive heard so many people use that line, and in the long run it's never different, it's a bear market rally thats why "it's different" to a bull market rally. Thats the only thing different, ones for suckers ones for investors.

Jun 08 09:03 AM

[seekingnorm...:]

hope you're right mate. i'm shorting


On Jun 08 09:03 AM maxe wrote:

> "This time it's different", ive heard so many people use that line,
> and in the long run it's never different, it's a bear market rally
> thats why "it's different" to a bull market rally. Thats the only
> thing different, ones for suckers ones for investors.

Jun 08 10:03 AM

[TradingHelp...:]

Great article. I think it's tough though to talk about valuations when useful valuations need accurate information about future earnings. I struggle to think of a sector where the future is certain enough to come to a "undervalued" or "overvalued" conclusion. I would prefer to focus on less quantitative measures such as sentiment and momentum, poor scientific measures as they are. Stocks can be priced at price extremes relative to future earnings so a shorter investment horizon actually has less risk, I feel, than investing deep into the future. And if you have a shorter investment horizon, momentum is much more relevant than 2012 earnings..... for example. Excellent article though.

Jun 08 10:51 AM

[AndrewBaker:]

Small caps got hit harder as they tend to do in most bear markets, so they have further upside potential comparatively, and as such are worth buying when an uptrend is seen. Beware, however, that the current uptrend is in a bear market rally, so be quick to sell as soon as the next leg down starts, which will be either towards the end of summer, if we can last that long, or when we actually get some real economic news broadcast which does not have government spin on it to make it sound good

Jun 08 11:10 AM

[MGA_1:]

The economy is still shrinking at a pretty good clip... I don't see how this can be good for the stock market. I'm looking at this current rally as a bear market rally and wouldn't doubt if we retest the 6500 low in the not too distant future.

Jun 08 11:56 AM

[joes:]

It is always interesting to see the confidence in this being a bear market rally, especially in awe of the folks that are looking at a big short position in a market that is still nearly 40% below where it was a year ago.

I've been long throughout it all, with a nice buffer of cash since I live on investments not paychecks. There are some great companies emerging from this mess and you won't find them with a standard review of fundamentals.

Jun 08 01:10 PM

[Fred Voetsch:]

On Jun 08 01:10 PM joes wrote:

> It is always interesting to see the confidence in this being a bear
> market rally, especially in awe of the folks that are looking at
> a big short position in a market that is still nearly 40% below where
> it was a year ago.
>
> I've been long throughout it all, with a nice buffer of cash since
> I live on investments not paychecks. There are some great companies
> emerging from this mess and you won't find them with a standard review
> of fundamentals.


Joe, you remind me of a relative who also is old enough to know better. Please take a day and do some real research. Turn off the TV or radio and look at how the market, after a long period of growth beyond its means, reverts to BELOW fair value and stays there for a decade or so. Then go find out what fair value really is. Do your own research and you will find out how much you are lied to by the financial media. They will do anything to keep you interested and that means keeping you bullish.

Start at my site for a few links to earnings data and economic data and then continue on until you come to your own conclusions. Question everything and verify. You may then disagree with me but since you have been long throughout this you obviously don't do your own research. Seeing this coming was as hard to see as a Mack Truck coming straight at you at 60mph...there's plenty more to come.

Jun 08 08:29 PM