Zacks Investment Management

Watchful investors may have noticed a trend that has taken shape over the last year and a half or so, as it relates to growth vs. value stocks. Namely, that growth stocks have been stoutly outperforming value stocks since the beginning of last year:

Growth Stocks (Red Line) Have Recently Outperformed Value Stocks (Blue Line)

Source: Federal Reserve Bank of St. Louis

Using data from the Federal Reserve Bank of St. Louis on the Russell 1000 Growth Total Market Index (which I’ll refer to simply as “growth stocks” in this piece) and the Russell 1000 Value Total Market Index (which I’ll call “value stocks”), we get a clearer picture. My napkin math shows me that on a pricebasis, growth stocks are up around 44% from the beginning of last year through the end of last week, while value stocks are up a much lesser 13%.¹

Investors who may have just become aware of this performance discrepancy – either through the above chart or elsewhere – may be experiencing a range of emotions, ranging from regret to resolve. Regret if you weren’t biased towards growth over the last year, and resolve if you decide that you’re going to increase your exposure to growth stocks going forward. I wouldn’t suggest either response.

There may be a few reasons that growth has been outperforming so widely, and also a few reasons why it may not be reasonable to expect the outperformance to last. Growth stocks, in my view, tend to outperform in “risk-on” environments, when investors’ appetite for risk assets increases whether due to better growth conditions, monetary stimulus, fiscal stimulus, deregulation, or some other positive force. Using just my short list, one could argue that the tax cut, deregulation efforts from the Trump administration, robust corporate earnings, and global synchronized growth have contributed to this “risk-on” environment.

By the same reasoning, however, an investor could argue that these factors contributing to a risk-on environment are by now either priced-in or going away entirely. The benefits of the tax cut, in my view, are largely priced, and the Federal Reserve is actively – though gradually – tightening monetary policy. As midterms approach, deregulatory efforts may take pause as campaigning takes over.

In short, I’m not so sure it makes sense for investors to feel regret or have resolve to shift towards growth stocks. I think the pendulum will swing back in due time, and perhaps sooner than many think.

What Does History Tell Us?

I’ll come right out with the answer: over time, value tends to outperform growth. Again, using data from the Federal Reserve Bank of St. Louis, we see that from December 31, 1978 (as far back as the data goes) to July 13, 2018, value stocks (blue line) have edged out growth stocks (red line) by a fairly significant margin:

Since 1978: Value Stocks +8,924% versus Growth Stocks +7,446%

Source: Federal Reserve Bank of St. Louis²

There are no definitive reasons for why value tends to outperform growth, but I have a few thoughts. For one, in my view, growth stocks tend to trade at higher multiples (they’re more expensive) while also having higher debt loads since they’re trying to grow into new markets. Higher leverage means higher risk, which tends to mean the potential for higher return, but can also mean falling further in a recession – or outright disappearing as we saw during the tech bubble in 2000.

Value stocks tend to trade at lower multiples, and value companies tend to have earnings that are more consistent/predictable with balance sheets that are more cushioned with cash. These are companies that also tend to pay dividends to shareholders.

As you can see from the chart above, value stocks have tended to chart a more gradual course higher, while growth stocks have experienced a more volatile run. What particularly stands out is the run-up to the 2000 tech bubble, where you see growth stocks surge higher only to fall faster. I’m not suggesting that’s what we’re seeing today, but it does leave open the argument that value stocks could weather the downturn better when the cycle finally does mature.

Bottom Line for Investors

Many long-term investors may see the bottom line here as: it’s better to just own value stocks over time. Not so, in my view. For equity investors seeking long-term growth, we think it’s important to have exposure to both growth and value over time. Diversification and risk control is a big reason for that, but it’s also to help ensure that you capture the relative outperformance of each category as leadership changes hands.

Trying to time when growth will do better or when value will do better is possible, but unlikely. That’s why, we like exposure to both, with emphasis on finding the right companies to represent each category.

To help you do this, I recommend reading our just-released Stock Market Outlook Report absolutely free.³

Disclosure