Conclusion: Value stocks have significantly outperformed year-to-date. There were a number of factors that contributed to this outperformance. To start the year, Value stocks traded at the largest discount to Growth stocks since 2000. The unexpected rapid rise in interest rates hurt longer duration growth stocks and helped some high-dividend payors like Utilities and sectors that benefit from higher rates like Financials. The rise in commodity prices was a big driver with the Energy sector being the largest performance contributor. We believe that the playing field is more even going into 2023 and the Fed may slow, maybe even halt, some of these trends, keeping us at a neutral position.
Style Cycle Duration & Return
Historical studies demonstrate that the Value style has outperformed the Growth style over long-term periods – domestic or international, large cap or small (Fama and French, et al.). Historically, style leadership changes have typically occurred near the end of an economic cycle as can be seen in the chart below. This did not occur in the COVID-19-driven downturn. We believe this is due in part to the nature of the environment that materially benefited many Growth companies and had the opposite effect on many Value companies. The pandemic may have delayed the transition. Recently, the relative performance of the Value Index moved up through a long-term downward trendline, which could indicate the beginning of a more sustainable period of outperformance.
Comparative valuation is difficult, as Value sectors and stocks tend toward valuation measures that differ from Growth sectors and stocks. In recognition of this, we have incorporated a number of different valuation measures. While relative valuation certainly leans Value, on an absolute basis the Value Index is not cheap relative to its own history. This helps explain why the Value index did not provide downside protection in the 2020 bear market.
- Generally, relative price performance follows relative earnings. It is difficult to compare earnings between the Growth and Value indexes as the Value index has both cyclical (e.g., Financials) and defensive (e.g., Utilities) stock exposure while the Growth index is composed of mostly less cyclical companies. The initial economic rebound helped Value earnings outpace Growth. This year, it is just two sectors, Energy and Materials, that are driving Value’s relative earnings outperformance.
- Another consideration for longer-term horizons is dividends. Dividend reinvestment has been a key driver to historical outperformance of the Value style over Growth. Currently, the Russell 1000® Value Index has a dividend yield (2.3%) that is more than double that of the Russell 1000® Growth Index (1.1%) as of November 30, 2022.
Value Poised to Do Better?
Another way to look at Growth versus Value is to consider relative returns on a rolling 10-year basis. The relative performance of both Small and Large Cap Growth indexes has started to come down from levels that were two standard deviations away from the historical average. Note how for the Small Cap indexes the Value style has historically dominated though they are nearly even in performance over the last 10 years.
Eugene Fama & Kenneth French, The Cross Section of Expected Stock Returns, Journal of Finance, June 1992.
This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.
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