Common Wisdom Unwound: Large Cap Growth Now

Between 1980-2006, U.S. equity index value stocks outperformed growth stocks*. The premium for remaining in value stocks during these years is dramatic with value gleaning 14-16% annualized return for the 27 years and the growth stocks between 10-12%. Midcap and small value did better than large value. All three did better than growth. Mid cap and large growth did better than small growth.

Further, the premium for value over growth was sustained during downturns according to Ibbotson Associates.** They compared the returns of growth versus value since 1969 during recessions that lasted six months or more. They found that value outperformed growth on average by 3.9% (growth stocks -0.8% and value stocks 3.1%).

Nevertheless, there are five year rolling returns when growth did outshine value. For example, between 1995-1999 U.S. equity index growth outperformed value dramatically. During this time, the large cap growth premium was 12.17%; the mid-cap was 8.97 and the small-cap was 8.31. This disparity between value and growth stocks at certain points in time suggests that similar disconnects will occur in the future. I propose that now is one such time.

Consider the recent and past performance of large cap growth IVW versus value IWD exchange traded funds. IVW outperformed IWD in the last three months in a down market. This suggests a momentum factor going forward for IVW.

Figure 1: Large cap growth IVW outperforms large cap value IWD last 3 months

As importantly, large cap value IWD outperformed IVW the lat five years suggesting that reversion to the mean is imminent. If this is the case, large cap growth will outperform large cap value IWD in the upcoming years.

Figure 2: Large-cap value IWD outperforms growth IVW 2003-2008. Is reversion to the mean imminent?

 

When small cap value and growth are compared, a similar pattern emerges, but to a lesser degree. Between 2003-2008, small cap growth IJT outperformed small cap value IWN only in the last year. This makes an immediate reversal to the mean less likely. Although small cap growth IJT did outperform small cap value IWN the last 3 months, each fall and rose with the market without diverging, one from the other., a different situation than large cap growth and value which are beginning to diverge. Therefore, the case for small cap growth over value in the coming years is less compelling than the large cap scenario.

Will large cap growth go against its historical lackluster performance compared to value and outperform it in the coming years? My guess is that will be the case. This is why. First, there is evidence that a reversion to the mean could be imminent or already started. Look at the recent flat IVW when IWD is dipping. Further, large cap growth costs less than value right now because it has been beaten down further. Therefore, it has more potential to climb.

*“The Frontier from Different Views: Size and style matter out on the frontier” by Craig Israelsen in Journal of Indexes, July/August 2008, pages 26-29 & 57.

** “Recession-Proof Investing” by Richard Gibbons, June 20, 2008 on Motleyfool.com.

Disclosure: Author owns several thousand shares each of the above-listed ETFs

Comments

[MyMoneyMD:]

Since January, 2009 large cap growth IVD has outperformed large cap value IVW by a premium of 10-11%.

Jun 17 07:29 AM