Value vs Growth Style Update
The markets have been rallying on the back of rising oil prices, continued good news regarding the strength of the U.S. economy and a lack of bad news from China and the Middle East. Some major U.S. stock indexes have recovered the majority of their losses from earlier in the year. MLP values along with some foreign equity values have also rebounded significantly. The following is price-only information as to how various markets have performed of late.
A couple of notes regarding the data above.
- Most major stock markets have experienced a reasonably significant rebound in pricing since the lows earlier this year. From its closing low on January 20, the S&P 500 index has climbed 10.32 percent, almost fully erasing this year’s downward shift.
- Gold prices have had a strong upward move from the lows reached at the end of last year. The metal’s price is up 18.8 percent this year.
- Some argue that gold is a metal whose value is “fake” or “non-economic”. I beg to differ. While I don’t consider myself a gold “bug”, I firmly believe gold pricing carries a reasonably strong negative relationship with the value of the U.S. dollar to foreign currencies. The reasoning behind this is that gold is normally part of a nation’s currency reserve pool. If central bankers don’t like the dollar, they tend to buy gold.
- The real reason I put the gold price issue in here is that gold has rallied throughout this swoon period of the world’s stock markets. This is a sign of investor “capitulation”.
Is the recent downward shift in markets complete? Frankly, I don’t know – nobody does. The drivers of the recent downward move in the markets are various as I have written extensively on these topics in the past. However, I don’t believe any of the negative fundamentals have changed over the last month or so. My base case of “Head Down, Eyes Up, Moving Forward” remains in place. Irrespective of market movement, expect that movement to be swift and volatile.
The fundamentals of my base case remain:
- The United States stays out of recession in 2016 (the probability is higher than normal this year - this is important for many reasons).
- The Fed eventually raises interest rates again before the end of the year.
- The market price volatility drivers remain in place (China deceleration, oil price volatility, U.S. Presidential election…etc.)
- Europe and Japan continue to try to find out how to grow their economies (hint: get government out of the way).
- In the end, the U.S. stock market (S&P 500) generates a positive return this year.
Update – Value vs. Growth
On January 25 of this year, I sent out a market update piece which talked about value investing as compared to growth investing. Without getting into the granular detail of this issue, most companies’ stocks are considered by the professional investment industry as either being primarily a value oriented stock or a growth oriented stock.
Background – Value vs. Growth
Value stocks tend to sell at lower multiples (of earnings, cash flow and book value) and by large tend, on average, to be more mature organizations. Growth companies on the other hand, are organizations whose income and profits have tended to grow more rapidly, on a consistent basis than their value oriented cousins.
Over various periods of time, generally speaking, either value or growth oriented stocks will tend to outperform the other. There are many variables which lead into this phenomena, including interest rate shift, availability of capital and sector profit variance. But perhaps one of the more driving forces behind growth outperforming value (and vice versa) is overall corporate profit growth rates.
According to our friends at Ned Davis Research (NDR), value oriented stocks have performed better than growth stocks when corporate profit growth rates are accelerating. Last year, the S&P 500 reported profit growth was $93.03 or down 9.1 percent from the earnings reported in 2014. This decline in earnings was primarily due to the collapse in earnings from oil companies as oil prices declined significantly during the year. And true to form, growth stocks dramatically outperformed value stocks last year by more than 9 percent!
Value vs. Growth - 2016
So much for last year. What about this year? Well, the consensus view has held that corporate earnings are expected to rise by 16.4 percent from last year’s dismal showing. The following is historical data as to how value oriented stocks have performed in relation to growth oriented stocks in various earnings accelerating/decelerating periods.
This data covers the market’s reaction over the last 35 year period (1980 – 2015). It is clearly seen that during periods of earnings growth deceleration (as was the case last year), growth stocks have outperformed value stocks. It is equally clear to see that during times of rising earnings growth rates (as may be the case this year); value stocks have outperformed growth oriented stocks.
How have value stocks performed so far this year, now that most analysts expect to see a rising earnings growth rate as compared to last year? The following is price performance of two like index investments, one focusing on growth stocks and the other on value stocks.
You can see that since the date of my last writing on this subject (January 25) the value oriented ETF has outperformed the growth oriented vehicle by more than 3 percent.
Other Drivers to the Value vs. Growth Return Disparity
As was originally covered in my piece from January 25, the construction of the value and growth indexes are significantly different. The two most heavily weighted sectors of the growth index are technology and consumer discretion stocks. These two sectors make up a whopping 48 percent of the growth index. On the other hand, the two most heavily weighted sectors of the value index are finance and energy stocks. These two sectors represent 43 percent of the value index.
Since finance and energy represent 43 percent of the value index, this index is much more sensitive to both interest rate and oil price shifts. If the price of oil increases, and interest rates increase, the value index could more easily outperform the growth index.
As we all know, interest rates and oil prices have both been low or declining. It is in the face of this fact that value oriented stock indexes have underperformed their growth cousins. I believe the worm is turning in both of these fundamental facts.
Historical Track Record – Value vs. Growth
Going back in time, there have been long stretches when growth has outperformed value and visa-versa. Below is the historical track record of market style bias.
Periods when value has outperformed growth
Periods when growth has outperformed value
As noted above, the current growth biased cycle is 9.5 years in duration. This is the longest period of time over the last 38 years of either growth or value outperforming the other style bias. In other words, this cycle is getting “very long in the tooth.”
With all the evidence above, I wouldn’t be surprised to see a shift in investor preference, away from growth-oriented strategies towards value-oriented approaches. Per the data above, the value vs. growth bias has generated very disparate returns over long periods of time. It has paid to keep track of this investor bias.
Application of Value vs. Growth Bias
Should you have money invested in value biased stocks? That depends greatly on your financial needs and only your wealth advisor knows the answer to this question for you. If you believe oil prices and interest rates are, over a long period of time, going to move upwards, you may wish to think of creating a value style bias in your U.S. equity portfolio. If, on the other hand, you think oil prices and interest rates will continue to decline over the long term, a growth bias may be appropriate for you.
I believe, over the long term, that a value bias has a good chance of outperforming a growth bias. The market’s stylistic bias seems to be changing.
An Ending Note
Most individuals who know me or follow my work understand my more conservative bias toward many issues in life. Certainly, I am conservative in my views as to the meaning and role of governmental systems in our world. Many who know me are also aware that I have a portrait of Ronald Reagan hanging in my office. President Reagan has been my favorite President of the United States in my lifetime.
Nancy Reagan, Ronald’s wife passed away on March 6, 2016. I have been blessed in meeting a few global political leaders in my lifetime. Unfortunately the Reagans are not among those whom I’ve met. They will be sorely missed.
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