Growth has outperformed value for nearly six years—the longest stretch of outperformance since 1932. In fact, growth’s outperformance has reached a greater-than-one standard deviation event versus the long-term average.
Could growth continue to outperform? Could it accelerate? Could we see what we saw during the dot-com era leading up to 2000? We would not rule this out. But we think the trend is more likely to turn in value’s favor. Two potential catalysts are especially relevant.
The first relates to Financials, which typically have a larger allocation in the value benchmarks. For example, as of December 31, 2013, Financials represented 29.8% of the Russell 3000® Value Index, compared to only 5.5% of the Russell 3000® Growth Index.
We believe the relative performance of Financials has been suppressed by quantitative easing. We expect the Fed’s QE tapering to be positive for the spread between the 10-year Treasury note yield and the 30-day Treasury bill. A steeper spread should be good for the Financials’ relative performance, and therefore good for value versus growth.
Second, although the outlook for the consumer is much better than in recent years, valuations in the Consumer Discretionary sector—a large component of growth indices—are concerning. The sector's two-year forward P/E is now above its long-term average.
The group also appears to be moving somewhat irrationally. Until about two years ago, the sector had been tracking the Consumer Discretionary Revisions Index, which takes the number of upward two-year forward EPS revisions on a weekly basis and compares it to the number of downward revisions over the same period. More recently, revisions have been flat but the sector’s relative outperformance has been striking. This divergence is a red flag. The fundamentals may be less robust than has been discounted in stocks thus far.
Because Consumer Discretionary is so heavily represented in growth compared to value (19.6% of the Russell 3000® Growth Index, compared to only 6.9% of the Russell 3000® Value Index, as of December 31, 2013), a decline in the sector’s relative performance should also favor value versus growth.
Disclosure:
Past performance does not guarantee future results.
The statements and opinions expressed in the articles or appearances are those of the author. Any discussion of investments and investment strategies represents the Firm’s investments and portfolio managers' views as of the date created and are subject to change without notice.
Economic predictions are based on estimates and are subject to change.
Sector classifications are generally determined by referencing the Global Industry Classification Standard Codes developed by Standard & Poor’s and Morgan Stanley Capital International. Sector allocations are a percent of equity investments and subject to change.
Value and growth and investing have unique risks and potential rewards, and may not be suitable for all investors. A growth strategy emphasizes capital appreciation, whereas a value strategy emphasizes investments in companies believed to be undervalued. A growth strategy typically carries a higher risk of loss and potential reward than a value strategy.
Standard deviation is a measure of volatility of returns. It is calculating by determining the square root of the average squared deviation of the returns from the mean value of the return. The Russell 3000® Growth Index measures the performance of stocks in the Russell 3000 Index that have higher price-to-book ratios and forecasted growth characteristics. The Russell 3000® Value Index measures the performance of stocks in the Russell 3000 Index that have lower price-to-book ratios and forecasted growth characteristics. Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Treasury yield is the effective rate of interest paid on a debt obligation issued by the U.S. Treasury for a specified length of time. A Treasury Bill, or T-bill, is a short-term debt obligation backed by the U.S. government. It has a maturity of less than one year. T-bills are sold in denominations of $1,000, up to a maximum purchase of $5 million. They and commonly have maturities of one month, three months, or six months. A yield spread is the difference between yields on differing debt instruments. It is calculated by deducting the yield of one instrument from another. The price-to-earnings ratio (trailing) of a stock is calculated by dividing its current per-share price by its per-share earnings from the last four quarters. Earnings per share is the proportion of a company’s profit allocated to each outstanding share of common stock.
© Heartland Advisors
