Conclusion: Both Value and Growth stocks declined in 2022, though Growth stocks fell much further than Value stocks. The rise in interest rates appears to be the most likely reason for this underperformance as earnings trends were not that different. Growth stock prices tend to reflect a greater portion of future value than Value stocks. At least theoretically, as interest rates rise, prices need to fall to adjust to a lower value of discounted future earnings. Assuming that the discounting process is over, we see a more even playing field between Growth and Value stocks.
Style Cycle Duration & Return
Historically, style leadership changes have typically occurred near the end of an economic cycle. 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, though we would want to see some relative earnings strength for confirmation.
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.
- It is interesting to note that Value’s outperformance last year was not accompanied by relative earnings strength. This is consistent with the notion that Growth stocks underperformed as they repriced lower due to higher interest rates and not a change in relative fundamentals.
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.
Glossary of Investment Terms and Index Definitions
Eugene Fama & Kenneth French, The Cross Section of Expected Stock Returns, Journal of Finance, June 1992.
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