Value stocks, those with low price to earnings ratios, have been getting hammered on a relative basis to their more expensive/growth peers in the last several years. 2020 and Coronavirus only poured fuel onto the dumpster fire that is value.
The first several months of this year featured mega cap technology growth stocks once again surging while small cap value struggled as that size & style was at center of the pandemic’s impacts.
Taking a step back, the trend of growth equities beating value actually goes back to the late 1970s. As the economy slowly began to exit the sharply inflationary period of the 70s and toward a time of declining interest rates, that is when investors shifted their value vs. growth allocation.
The Chart of the Week below is from Market Cycle Guidebook which contains more than 70 charts highlighting key intermediate-term drivers of risk and return across the global asset environment. It shows a ratio line of the cheapest quartile of industries versus the most expensive quartile (disregarding the middle 50% of stocks).
At Topdown Charts, we prefer to use a blend of valuation tools when analyzing how cheap or expensive asset groups are. Here we combine five common valuation ratios to come up with our Composite. You could say we would rather be approximately right than precisely wrong, to quote Keynes.
By this look, the cheapest versus the most expensive were largely a wash since the late 70s – aside from the late 90s to early 2000s when value stocks were shunned during the dot.com bubble only to be fallen in love with once again post-2000. Value vs. growth then took a nosedive of late when FAAMG (or whichever acronym you prefer) dominated. The cheapest industry groups now find themselves at the biggest relative discount to the more expensive in nearly 20 years.
These are not short-term trends. We respect trends and appreciate technical analysis, so it can be painful to allocate heavily toward niches of the market like value if you are anticipating a quick mean reversion. Markets rarely work like that. Trends tend to persist longer than investors predict. Nevertheless, we consider what has (and has not) worked well when formulating our longer-term capital market expectations and asset class expected returns.
At the stock-specific level, diving deeper from the industry valuation perspective, below is the S&P 500 value versus growth performance ratio chart since the 1970s with a trendline overlay. This chart has fallen below its early 2000s trough, making essentially fresh all-time lows. This is the usual ‘value versus growth’ performance look you may be used to seeing.
In the aforementioned capital market expectation changes, our US large cap growth outlook turned less favorable given the sharp rebound in equities since the end of March. Topdown’s expectation for non-US equities also took a dip, but remains materially above that of US stocks. It is interesting to analyze the composition of US large cap stocks versus the developed market (ex-USA) and emerging market universe.
Developed (ex-USA) is tilted more to large cap value while the S&P 500 has drifted to mega cap growth. Emerging markets also have a slightly more value-orientation versus the S&P 500, though high weights like Alibaba & Tencent make for a larger average market cap than the developed (ex-USA) index. So it is natural that non-USA stocks have performed relatively poorly to the S&P 500 given the makeup of the indexes.
Recall the period of the early to mid-2000s when value beat growth – it was a time in which commodities outperformend, interest rates were on the rise, and foreign equities beat US stocks. The US Dollar also fell from 120 to near 70 during the 2002-2008 period. All of these factors work together in the macro environment.
Being aware of changes to intermarket movements is important to portfolio management. It was a fleeting time of course as those market trends reversed.
What will it take for the ‘cheap industry’ valuations to come back? It will likely be a broad change in the global marketplace, and it will take time. However, those broad changes, like the tides of the oceans, do have a way of moving back and forth.
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