Another Look At Growth Versus Value

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by: David I. Templeton, CFA

Writing blog commentary serves as a permanent record of one's thoughts at a specific point in time. When reflecting back on earlier posts, expectations and conclusions do not always unfold in the market or economy as anticipated and written about at that time. The benefit is one can adjust future thinking and conclusions if necessary. Sometimes events occur that one simply could not anticipate and the events result in a change of direction in the market. All investors would benefit in tracking how they arrived at their investment decisions..

It seems over the last few weeks there has been much written about the outperformance of growth stocks versus value stocks. The extended outperformance of growth over value has pushed the relative valuation to a high for the growth style and a low for the value style and was referenced with a chart in the June monthly presentation by State Street Global Advisors. The below chart is a slightly different version but shows the higher relative valuation of large cap growth versus large cap value at this point in time.

I believe one of the most difficult projections to get correct is drawing a conclusion about the growth versus value equity style. As the below image shows, there are factors associated with the economy (where is the economy in relation to the business cycle) and then specific factors related to stocks and bonds and getting most of these variable forecasts correct can be a difficult task.

Source: iShares by BlackRock

Nonetheless, I have written articles over the past few years regarding the growth versus value style.

The 2016 analysis turned out to be correct as value outperformed growth in 2016. In 2014, growth and value returns were nearly identical as can be seen in the calendar year return chart below, but growth outperformed value in the following year.

The below chart shows a longer view of the growth and value cycle. In the run up to the technology bubble in 2000, growth was the outperforming style, although value generated brief periods of outperformance like in late 1999. During the economic expansion that followed the bursting of the technology bubble and the lead up to the financial crisis in 2008, the value style had a sustained period of outperformance. The yellow highlight on the below chart represents the March 2014 article date noted above and where value had a brief period of outperformance.

And finally, should an investor favor one style over the other. Over the long run value has outperformed growth. however, as seen in the calendar year return chart, value can go through periods of significant underperformance when growth is in favor. Value tends to shine in down markets and that is something for investors to think about. I will comment more on this in the conclusion.

The below chart shows value versus growth performance over two distinct time periods. The top chart represents a 20-year time frame and the bottom chart represents a 10-year time frame. In short, the time frame over which performance is compared is important. Value is outperforming over the 20-year period while growth is outperforming over the 10-year period.

Below is content taken from my March 2014 article in reference to growth versus value and where the economy is in the business cycle.

The importance of this fact has to do with the performance of these two styles relative to the economic or business cycle. As noted in a white paper, Forecasting Performance Cycles of Value and Growth Stocks in Global Equity Markets, written by David Kovacs, CFA of Turner Investment Partners,

Following periods when short-term rates ease, lending activity and subsequently business development typically accelerate. During these periods value stocks, led by financial and industrial companies, begin to outperform. As the global economy begins to expand, demand for basic materials, such as metals, and energy related commodities, such as oil and natural gas, rises. That leads to an increase in the price of these commodities which in turn has historically led to the outperformance of the stocks of commodity producers and processors.

As in the case of an economic slowdown, the monetary response to economic expansion is also typically delayed until sustained signs of acceleration in inflation are apparent. In response, central banks begin to hike short-term interest rates to the point where the interest rate yield curve is flat or inverted, i.e. short-term rates are either equal to or higher than long-term rates. Lending activity to businesses then typically slows significantly, profits of financial institutions decline, and financial stock prices begin to lag the market averages. Economic activity moderates, and once again those stocks that can grow their earnings at the fastest pace, namely, growth stocks, typically resume a period of multi-year outperformance.

In short, as the economy begins to accelerate, value companies begin to outperform. Conversely, when the economy begins to slow, those companies that can grow their earnings in spite of the slowing environment (growth stocks) will begin to outperform.

In conclusion, as clearly seen in the calendar year return chart above, value has a history of holding up better in down markets. In investing though nothing is 100% certain. Jeff Miller who writes a Weighing the Week Ahead commentary, had good insight this week for individual investors in the article titled, Do Individual Investors Face a Pivotal Decision?, He notes,

[one}...needs to understand the market fundamentals, ignore the noise, find relevant data to compare approaches, resist the chase for yield, and think for the long run. Most importantly, have a plan for a major market decline. Without one, you will never stick to your program.

Jeff's complete article is a worthwhile read for other useful individual investor insight this week.