Even in a Down Market, Growth Outperforms Value

Over the last year, the average SP500 stock is down about 14%, with the peak back in October. Historically during down markets, "growth" stocks tend to underperform "value", perhaps due to their greater market sensitivity (beta) or that value stocks are relatively cheaper in the first place. Since 1970, the performance of large cap value has been about the same as large cap growth during positive markets, but value falls less than half as much as growth during market declines.

This relationship has been reversed over the last 12 months (and longer) during the credit-crunch-inflation-spiking-confidence-declining market. Indeed, the Vanguard Value Index is down 10.3% over the last year whereas the Vanguard Growth Index off only 2.75%. So yes, Growth is doing better than Value, but unusually so in a bear market.

Analyzing sources of returns, I looked at the top/bottom quintile spreads of SP500 stocks ranked by various growth and value criteria. For example, the spreads between stocks ranked by earnings estimate revisions, upward vs downward, was 15%; for annual earnings growth (high vs low) over 22%; High vs. Low Price/Book has been an astounding 29%; and Forward PE (low vs high) -1%.

The reversal and magnitude of Price/Book's discrimination (in)ability seems remarkable to me, since a basic tenet of (value) investing is to buy income-producing assets as cheaply as possible, and a low price relative to ook Vallue is the metric used. Yet, the inverted relationship suggests that investors are favoring stocks with less asset-intensive income-generating potential. Whether this is some sort of "investment paradigm shift" or not is hard to tell. I don't think that investors should give up on favoring low price-to-book stocks completely, though they will probably continue to lag.

The factor analysis clearly shows that investors are favoring stocks with improving earnings expectations, stronger than average earnings growth, with little concern for the price paid relative to expected earnings or relative to the amount of assets deployed. For the last year and into June so far, investors are gunning for growth, regardless of market direction or price paid relative to intrinsic value. One wonders with the market turbulence and uncertainty when value-oriented stocks will start to re-assert their traditional "safer-haven" / better relative performance relationship of the past.

Comments

[Scared Stiff:]

Good article. It's another symptom of this totally insane, topsy-turvy, unpredictable market.

2008 Jun 11 07:06 AM

[kotika98:]

there is a simple explanation for al this, it is the financials that looked like they were good value a year ago, the financials were the sector with lowest price-to-book, and financials were the stocks to take the largest beatings. You need to look no further than Bill Millers troubles for a proof.

2008 Jun 11 09:40 AM

[Bear Stocks...:]

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2008 Jun 11 11:32 AM