Growth Vs. Value

Style investors recently witnessed a rare event when, on February 13^th, the P/E ratio of the S&P 500 Growth Index fell below that of the S&P 500 Value Index. At first glance, it is tempting to attribute this valuation flip-flop to the 2022 bear market, which saw Value outperform Growth by a whopping 24.2%. However, the bear-induced collapse of Growth stock prices in 2022 only served to return the P/E spread to a level just below its historical median of 5.1, meaning that the final move toward parity was caused by a force outside the market itself. That “something else” was the S&P 500 style reconstitution that occurs annually on the third Friday of December.

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While the valuation gap between Growth and Value sectors was compelling just a couple of years ago, it has closed drastically the last twelve months. Our analysis shows that Value sectors (Energy, Industrials) are still more favorable than Growth sectors (IT, Health Care).

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The China-reopening theme is alive and well, which will likely support cyclical outperformance. The disinflation trade is at a crossroads. Value/Growth started to decouple from interest rates.

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S&P rebalanced its style indexes in December, and the shuffle caused substantial turnover. The Value index now includes a sizeable swath of mega-cap tech companies, and this changing membership significantly affects the relative valuation metrics that defined those styles.

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Deflating valuations in the Technology and Innovation space produced ghastly results for growth investors in 2022, with the S&P 500 Growth index experiencing an agonizing 29.4% loss. Meanwhile, last year’s bear market was no more than a mild irritation for value investors as the S&P 500 Value index lost just 5.2%. The collapse in exuberantly priced growth stocks produced a 24.2% return spread between the value and growth styles, which goes into the record books as the second biggest annual win for value since 1975.

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The six-week rally that started mid-June featured advances from AAPL (+25%), AMZN (+30%), and TSLA (+39%), which accounted for one-fourth of the S&P 500’s gain. Despite the recent preference for Value, a spike in interest rates, and the bear market, the index’s concentration in the top-five firms is still near it’s all-time high set in August 2020.

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Mystery writers are fond of creating misdirection by introducing multiple eyewitnesses that each describe the crime differently. This plot device confuses the storyline until a clever detective comes forward to unravel the conflicting evidence and solve the mystery. 

This scenario played out in style returns for 2021, as shown in Table. Our first witness is a large cap manager who tracks the S&P 500 and reports another banner year for Growth, its seventh win in the last ten years. Our second observer is a small cap manager who watches the broader market and tells of Value’s excellent year. Meanwhile, our third bystander is an international manager tracking EAFE, who reports seeing a whole lotta’ nothing in the style derby last year. In this study, we channel our inner Hercule Poirot to determine what, in fact, did happen across domestic style returns in 2021.

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It is a scene easy to imagine: Two children on the playground arguing about who’s the top dog. This schoolyard scuffle played out in 2021 between the Value and Growth styles, with each claiming bragging rights from their own perspective.

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One measure of a bubbly bull market is the degree of speculative fervor embedded in the prices of companies with nebulous, indeterminate, or even nonexistent intrinsic values. Since the bear market low in March 2020, speculative manias have evolved in a menagerie of asset classes including Innovators & Disruptors, SPACs, meme stocks, crypto currencies, and NFTs. Based on the breadth of valuation extremes across numerous and diverse assets, this bull market may rank second to none.

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An unprecedented number of companies are still deep in the red, even while the economy is shrugging off the impact of the pandemic. Small-cap growth companies are showing no sign of a quick recovery.

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The performance derby between actively managed portfolios and passive benchmarks is strongly influenced by market conditions.  Active manager success rates are cyclical, but not random, and are driven by slippage created from style, size, and weighting considerations that result from the imperfect slotting of active portfolios into single style boxes.  Moreover, this slippage can be defined and measured, and shows a clear correlation with relative return spreads between benchmarks and their opposite boxes.

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Top decile valuations are often the result of unduly positive investor sentiment that leads to inflated multiples. Bullishness comes in varying strengths: optimism, enthusiasm, exuberance, and, at the extreme, the mania of crowds. Because bullishness manifests itself in aggressive valuations for speculative companies, we believe the prices being applied to such companies - for which intrinsic value is dependent on a future that looks significantly different than today - are an excellent measure of investor sentiment. In that spirit, we examined past cycles of extreme valuations with the goal of understanding how they relate to investor sentiment and what they might tell us about market conditions and relative returns.

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Investors looking for the long-awaited rebound in the Value style point to the potential for rising interest rates as a possible driver of style rotation. Higher rates would benefit many Financial companies, a sector closely linked to the Value style. In fact, many commentators believe that the Value style cannot experience a major run without the participation of Financials. We launched a research effort to examine the link between Financials and Value, seeking to understand whether there is truth in this old saw, or whether this connection is more properly classified as market folklore.

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Investors looking for the long-awaited rebound in the Value style point to the potential for rising interest rates as a possible driver of style rotation. Higher rates would benefit many Financial companies—a sector closely linked to the Value style. In fact, numerous commentators believe that Value cannot experience a major run without the participation of Financials.

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Presidents and the popular press have become obsessed with performance over the “first 100 days” in office. That prompted us to see if there have been any persistent stock market effects related to this 100-day window. There are many ways to slice the data, and the more we sliced it, the fewer the observations.

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Often, what market pundits like to pass off as bold, contrarian forecasts are merely rationalizations and extrapolations of trends that have already been in place for some time.

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If there’s an emerging bubble in Growth stock investing, it certainly doesn’t apply to Small Caps. The “usual” premium for Growth over Value within the Small Cap space is nonexistent—both segments look historically cheap.

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Growth investing is in the midst of a spectacular run this year, extending its decade-long dominance over the Value style. Chart 1 depicts the Growth / Value relationship over the last 25 years through July 31^st, with key turning points marked by vertical lines.

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Growth investing is in the midst of a record run this year, extending its decade-long dominance over the Value style.

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