Style Drivers
Conclusion: Value stocks have significantly outperformed year-to-date. There are two main drivers for this outperformance. One is rising interest rates, which are hurting longer duration growth stocks and helping some high-dividend payors like Utilities and sectors that benefit from higher rates like Financials. The other is economic growth, which is helping more cyclical value stocks. We believe that the Fed is on track to slow, maybe even halt, 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.
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.
Relative Valuation Measures
Based on the Russell 1000® Value and Growth Indexes
as of May 2022
| Rank 1-5* | |
|---|---|
| Price/Cash Flow | 2 |
| EV/EBITDA | 2 |
| Price/Sales | 2 |
| Price/Trailing 10 Year EPS | 2 |
| Forward P/E | 2 |
| Summary Signal (Average) | 2.0 |
**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 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 (2.1%) that is more than double that of the Russell 1000® Growth Index (0.9%) as of May 31, 2022. In the second half of 2021, dividends paid exceeded the pre-pandemic peak, yet the payout ratio remains well below the pre-pandemic level.
*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 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 and has already pulled ahead.
Source: Frank Russell Company
Glossary of Investment Terms and Index Definitions
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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