Style Drivers
Conclusion: After a significant cyclical earnings rebound, expected earnings growth and upward revisions have moderated for the Value Index. A downshift in economic growth due to the Delta variant, continued supply chain issues, and a flattening of the yield curve are all having a more negative impact for Value stocks versus Growth stocks. On the other hand, Growth stocks are expected by analysts to grow earnings by 37% over the next 12 months (through 2Q 2022 for the Russell 1000® Growth Index) which appears pretty optimistic and valuations leave little room for disappointment. We suggest a more balanced and selective approach to style investing.
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 this COVID-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 simply delayed the transition.
Sources: Frank Russell Company, Bloomberg
Relative Valuation
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. That said, it would be historically consistent for Value stocks to outperform in the initial stages of a recovery and relative valuations are supportive of that.
Relative Valuation Measures
Based on the Russell 1000® Value and Growth Indexes
as of August 2021
| Rank 1-5* | |
|---|---|
| Price/Cash Flow | 2 |
| EV/EBITDA | 1 |
| Price/Sales | 1 |
| Price/Trailing 10 Year EPS | 1 |
| Forward P/E | 1 |
| Summary Signal (Average) | 1.2 |
**Average of the five relative valuation measures.
Sources: Frank Russell Company, Bloomberg
Relative Fundamentals
- Generally, relative price performance follows relative earnings. It is difficult to compare earnings between the Growth and Value indexes as the Value Index is more cyclical while the Growth Index is more stable. The initial economic rebound helped Value earnings outpace Growth. Yet, the cyclical tailwind appears to be diminishing. Forward estimates for the Value index have not kept pace with the Growth index. We believe this is likely due to slower re-opening due to the Delta variant, continued supply chain issues and a flattening yield curve.
- 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 (1.9%) that is more than double that of the Russell 1000® Growth Index (0.7%) as of August 31, 2021. Last year, many dividends were suspended. In the second quarter of 2021, announced dividend increases amounted to $15.6 billion, up 130% versus a year ago.
*Normalization adjusts or rescales the values of different time series to a notionally common scale to allow for comparability.
**The spread is the difference in the normalized units in the chart above.
Sources: Frank Russell Company, Bloomberg
Value Poised to Do Better?
Another way to look at the Growth versus Value story comes from The London Company. Looking at relative returns on a rolling 10-year basis, one can see that the performance of both the Small- and Large-Cap Growth Indexes is nearly two standard deviations ahead of their respective Value indexes. The last time we saw this was at the tail end of the Dot-Com boom.
Source: Frank Russell Company
Glossary of Investment Terms and Index Definitions
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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