By Guest Blogger Doug Rowat
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Growth versus value. It’s a rivalry as old as time. It’s the investment industry’s equivalent of the Red Sox versus Yankees.
And like the Red Sox versus Yankees, the Bronx-Bombing growth stocks over the long term have generally trounced the underdog value-stock Beantowners:
S&P 500 Growth Index (blue line) vs S&P 500 Value Index (white line – long term
Source: S&P, total return performance
Growth stocks have, in fact, returned an incredible 16% annually over the past decade versus 11% for value stocks. The value-stock rate of return is still impressive, but somehow it’s always overshadowed by its pinstriped growth-stock rivals. However, every once in a while, value stocks shrug off the demons of Bill Buckner, throw a bleeding Curt Schilling onto the mound and pull off an impressive victory. We may be witnessing such a value-stock win as we speak.
First off, what are value stocks? Value stocks, as the name implies, are underpriced equities, and because they’re underpriced, they’re often out of favour. Following the 2008-09 financial crisis, for instance, a lot of “value” could be found in US banking stocks or US homebuilder stocks. Similarly, the Covid-19 crisis, has created pockets of deep value as well.
An excellent example of a Covid-19 value stock would be Walt Disney, which is heavily weighted in most value indices and value ETFs. Fairly or not, Disney was punished at the outset of Covid because many of its businesses were seen as susceptible to lockdowns: theme parks, cruise ships and film production studios, for example. With sports also shuttered, ESPN, a smaller Disney enterprise, was also viewed as a liability. The end result was a more than 40% drop in its share price from its pre-Covid peak to its March 2020 lows.
Two main factors, however, have driven a recent rally in value stocks: 1) the perceived unsustainability of growth’s outperformance and 2) the positive developments surrounding vaccines.
First, growth’s overextension. Growth stocks usually experience free-reigning momentum and are allowed by investors to become expensive because investors are willing to pay extra for the growth potential. However, growth stocks are being viewed now as excessively overpriced. The chart below, for example, shows the rolling 12-month price return between the S&P 500 Growth and S&P 500 Value indices. As the chart indicates, growth stocks recently hit a relative performance extreme. In fact, the highest in history, eclipsing the highs seen during the tech bubble of the late 1990s. Given the run in growth stocks, the compelling value, so to speak, that value stocks are offering hasn’t been lost on investors.
Growth’s relative performance extreme: the highest in history!
Source: CFRA
Secondly, vaccine news. Using Walt Disney again as an example, the emergence of effective treatments for Covid-19 from Moderna, Pfizer and AstraZeneca in just the past month has allowed investors to picture a more normalized world in 2021, one where consumers return to theme parks and cruise ships, for example. Whether this will play out as smoothly as investors hope is, of course, the risk, but for now, the vaccines offer the possibility of beaten-down value stocks returning to higher levels of profitability next year. As a result, value stocks have begun to more strongly outperform, with the outperformance coinciding almost exactly with the vaccine news:
S&P 500 Growth Index (blue line) vs S&P 500 Value Index (white line) – q-t-d
Source: S&P, total return performance
Whether the outperformance can continue remains to be seen, but as markets and economies emerge from a crisis is often when value stocks realize their best sustained outperformance. An overextended growth sector and vaccine developments are also likely to serve as additional catalysts for the value sector. Therefore, it’s worth having a portion of your portfolio in value stocks (within a well-diversified value ETF, of course).
As the market emerged from the financial crisis beginning in March 2009, value stocks outperformed growth stocks consistently over the next two years, and did particularly well during the first year of the market rally.
The same thing may happen as we emerge from the Covid crisis.
Growth is great, but not even the Yankees can win every year.
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Finally, I came across this nifty chart recently from Invesco. You might hate Biden and his economic policies or you might have hated Trump and his economic policies back in 2016, but this chart shows why it’s important to never let your personal antipathy towards a politician or a political party interfere with your investment decisions.
Democrat or Republican, never bet against America:
Growth of $10,000 in the Dow Jones Industrial Index since 1896
Source: Invesco
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.