Style Drivers
Conclusion: In recognition of sustained Growth outperformance, while our style drivers have been favoring Value, we have made a number of modifications to our approach. Currently we do see upside opportunity for Value stocks relative to Growth as the economy rebounds and especially if a vaccine is discovered and/or a viral resurgence does not occur. Beyond a cyclical rebound, though we believe that despite the wide relative valuation gap, the underlying fundamentals of Value stocks versus Growth may preclude a secular shift to sustained Value stock outperformance. Regardless of whether you favor Growth or Value, we believe that given the significant recovery in stocks one should employ a more selective approach to stock selection for the next leg of the recovery.
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.). Growth and Value style indexes have historically gone through extended cycles of relative outperformance and underperformance. Given these long cycles we have added a trend factor to our analysis. We understand that trend following will be late in identifying pivots and will result in false signals, but given the long periods of historical out and underperformance we believe a trend signal can aid our decision making process. This trend analysis will be combined with our previous signals based on cyclical factors and relative returns.
- 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 this crisis that materially benefited many Growth companies while harming many Value companies. In a rebound, this should reverse.
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 that cheap relative to history. This helps explain why the Value index did not provide downside protection in the 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 May 2020
| Rank 1-5* | |
|---|---|
| Price/Book Value | 1 |
| EV/EBITDA | 2 |
| Price/Sales | 1 |
| Price/Trailing 10 Year EPS | 1 |
| Forward P/E | 3 |
| Summary Signal (Average) | 1.6 |
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. This cyclicality can be seen in the most recent observation on the chart on right, where relative earnings dramatically went in favor of the Growth index. We anticipate that as the economy rebounds this will reverse. Looking further out in the cycle there is less visibility, but in an environment like we saw in the last cycle with low economic growth and low interest rates Growth companies may again be advantaged.
- 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 (2.8%) that is more than double that of the Russell 1000® Growth Index (1.1%) as of May 31, 2020.
*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 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.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
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