Don’t call it a comeback in value, because it may not be.
Over the past few weeks, one of the dominant narratives on Wall Street has been that value-based strategies could be poised for a rebound, following years of underperformance relative to both the broader market and growth-related plays. The overall economic environment—marked by rising interest rates and a less-certain growth outlook—is seen as more favorable to stocks viewed as undervalued, while investors are increasingly seeing the advance in growth shares, highlighted by huge gains in large-capitalization technology and internet shares, as overdone. Growth strategies tend to refer to investing in highflying stocks that consistently grow faster than their peers and the broader market.
Investors have warmed to this idea, resulting in the biggest shift from growth to value in nearly a decade, according to Nomura data. However, the move could be premature.
“While value stocks have been doing better recently versus growth stocks, the long-term trend still remains clearly in growth’s favor, and we believe it’s too early to start significantly shifting portfolios toward value sectors,” wrote Andrew Adams, senior research associate at Raymond James. “Given the obvious preference toward growth over the last several years, it will require more than just a few strong weeks for value to really prove it has turned a corner for the long run.”
Growth strategies have dominated since the bottom of the financial crisis, boosted by rock-bottom interest rates and the huge gains in tech stocks, what one analyst dubbed “possibly the greatest investment story ever told.” Since 2006, according to Raymond James, which looked at the growth and value tilts of the Russell 3000, there have only been three occasions when value performed better than growth for meaningful periods. In each case, however, growth swiftly resumed its upward momentum (as illustrated in the chart attached).
“That’s 12 years of lagging performance that value must contend with, and it’s a trend that we don’t really want to fight,” Adams wrote, adding that “it might take some sort of recessionary environment to really flip that relative strength.”
Beyond the momentum factor—something other analysts have cautioned may be drawing to a close—Adams said there were fundamental reasons why growth has outperformed in recent years, and that “these tailwinds do not really show signs of reversing anytime soon.”
In a report to clients, Adams dismissed the idea that rising rates would push investors from out of growth stocks. The industries that were vulnerable to this trend, he said, were defensive-based sectors like utilities or consumer staples. Such groups tend to pay higher dividends than the overall market, and this has made them more attractive than bonds in recent years.
“We feel that as rates rise, it’s more likely to first take demand away from the lower growth, higher dividend-yield stocks commonly used as bond proxies, rather than the high [earnings per share] growers. A stock with a 2-3% dividend and a lower expected growth rate simply becomes less attractive as interest rates rise, while a stock with the potential to grow earnings at a high rate isn’t as impacted by rising rates,” he wrote.
Growth strategies are heavily tilted toward large-capitalization internet and technology stocks, notably the FAANG group that includes Facebook FB, +0.75% Amazon.com AMZN, +1.29% Apple AAPL, +0.07% Netflix NFLX, -1.20% and Google-parent Alphabet GOOG, +0.27% GOOGL, +0.44% While some of these stocks have struggled lately, they’ve all been among the market’s best performers for the past several years, single-handedly helping to lift Wall Street overall.
Adams wrote that “the increase in importance to our overall economy of the technology sector and tech-heavy companies in other market sectors naturally favors growth strategies over value,” and that this wasn’t likely to change regardless of the economic environment.
“Companies that chiefly depend on innovation and continual progress, like those predominantly found in the technology sector, often trade at higher-than-average valuations but can still be attractive to investors because they are expected to generate better-than-average earnings growth in the future (even if they’re not currently profitable). As technology-based companies continue to increase in market and economic weight, it becomes harder for companies in more traditional value sectors to keep up.”
