Growth Or Value – That Is The Question
It’s a gross understatement to say growth stocks have outperformed value stocks significantly in recent years.
Year-to-date through 11/30, growth stocks (using Russell 3000 Growth Index as a proxy) outperformed value stocks (using Russell 3000 Value Index as a proxy) by 3,300 basis points (+31.8 percent versus -1.2 percent, respectively). Since the end of 2016, the last calendar year value stocks outperformed growth stocks (+18.4 percent versus +7.4 percent), growth stocks outperformed value stocks by nearly 9,800 basis points (+127.1 percent versus +29.1 percent).
However, the tide shows signs of turning since “Pfizer Monday” on 11/9, the day Pfizer announced its purportedly highly effective COVID-19 vaccine. On that day, value stocks outperformed growth stocks by 600 basis points (+4.3 percent versus -1.7 percent). Between 11/9 and 11/30, value stocks outperformed growth stocks by 670 basis points (+7.9 percent versus +1.2 percent). One has to wonder if value will now start outperforming growth or if this is just another misdirection.
Below we highlight some of the major risks in growth and value investing under the current market environment and whether a rotation to value is underway.
The Risks Of Investing In Growth Stocks
The biggest risks in growth investing are high valuations and rising interest rates. After years of strong performance, growth stocks are expensive by almost any metric. While unlike the dot com bubble era, most growth companies currently have sustainable businesses and are unlikely to fail, some of them have nose-bleeding valuations that can match that era. With sky-high valuations, equity investors can still lose should their valuations tumble.
Great business does not guarantee great investment returns, however. After the dot com bust, it took more than 16 years for Microsoft’s share price to climb back to its 1999 level, even though its business had been strong. As for Intel and Cisco, two very strong technology companies, their shares prices are still lower than they were 20 years ago during the height of the dot com boom.
The other potential threat to growth investing is rising interest rates. As values of growth companies come mostly from future earnings, higher interest rates make future earnings less valuable, resulting in less attractive growth stocks. Even though the Fed seems committed to near-zero interest rates, at least for the next couple of years, growth investors should be particularly vigilant for any increases.
The Risks Of Investing In Value Stocks
The biggest risks in value investing are the headwinds of secular trends and a fragile economic recovery.
Value companies in many industries were struggling long before the pandemic. They find themselves now on the wrong side of some of the megatrends we are experiencing, such as e-commerce and ESG. Even though their businesses are cyclical like other value companies, they have been disproportionately hurt by the pandemic and thus should theoretically benefit more from an economic recovery. Value investors should be particularly careful in choosing between “true cyclicals” and “secular decliners.”
The other potential threat to value investing is, of course, a fragile economic recovery. Value companies rely on strong economic recoveries to sustain and grow their businesses. Value investors should pay particular attention to the health of the overall economy. Even though we finally had a breakthrough in vaccine development, the path for economic recovery could be tricky as the virus’ impact has been hard to predict.
Frank Wei, CFA, CAIA, Vice President, Senior Investment Analyst
Mr. Wei is a Senior Investment Analyst on Envestnet | PMC’s Research team. Prior to joining PMC, Mr. Wei served as a Portfolio Manager and Analyst at FundQuest and was responsible for the oversight of separately managed accounts, as well as the management of client assets. Before joining FundQuest in 2001, he held positions at Salomon Smith Barney and ABN AMRO Securities as a Research Analyst and Equity Analyst, respectively.
Mr. Wei has over 10 years of industry and investment management experience. He holds a B.A. in Economics from East China Normal University and an M.B.A. from the Leonard N. Stern School of Business at New York University. He has earned the designations of Chartered Financial Analyst and Chartered Alternative Investment Analyst.