Over the past few years, value stocks have lagged significantly behind their growth counterparts. However, this trend is unlikely to persist indefinitely, presenting an attractive opportunity for investors to consider increasing their exposure to value stocks.
Growth vs. Value: The Numbers
Comparing the performance of the Russell 1000 Value Index and its growth counterpart provides a clear illustration of this divergence. While the Russell 1000 Value Index, which includes well-known companies like Bank of America, MetLife, and Union Pacific, has seen modest gains of around 2% this year, the growth index has soared by approximately 37%.
The Role of Big Tech
The impressive performance of growth stocks can largely be attributed to the influence of Big Tech companies. These industry leaders are expected to generate profits at a pace surpassing that of the average business, fueled by advancements in artificial intelligence. This heightened optimism regarding future earnings potential has propelled these stocks to new heights.
Value Stocks: Facing Challenges
In contrast, value stocks represent mature companies that have transitioned beyond rapid growth phases. Consequently, they are more susceptible to fluctuations in the overall economy. Until recently, concerns regarding the Federal Reserve’s campaign to combat inflation through interest rate hikes haunted the markets, creating uncertainty around future demand for goods and services. As a result, Wall Street analysts consistently revised their profit forecasts downwards for value stocks.
The Tipping Point
However, it’s important to recognize that the current outperformance of growth stocks relative to value stocks may not be sustainable. Since March 2020, the total market capitalization of companies included in the growth index has witnessed a staggering increase—nearly double that of the value index. At the beginning of this period, the growth index was only 40% larger. These stark discrepancies suggest that a reversal in performance could be on the horizon.
In conclusion, while growth stocks have undeniably dominated the market in recent times, the tide is likely to turn in favor of value stocks. Investors should seize the opportunity presented by this potential shift by considering a strategic allocation towards value stocks for a well-balanced and diversified portfolio.
Value Stocks: A Temporary Underperformance
According to market analyst Tom Essaye from Sevens Report, value stocks have been underperforming year to date. However, Essaye believes that this underperformance will only be temporary and that the tide will turn for value stocks in the near future.
Historically, whenever the growth index has doubled the capitalization of the value benchmark, growth stocks have experienced a prolonged period of underperformance before rebounding. This is because fund managers, who have heavily invested in growth stocks, need to rebalance their portfolios, causing them to shift their focus towards value stocks. This shift becomes even stronger if there’s a belief that economic growth will remain stable.
Currently, the case for value stocks is quite strong. While economic growth is expected to slow down from the third quarter’s inflation-adjusted 5.2% annual rate, a recession is unlikely for the United States. The Federal Reserve has not raised interest rates since late July, leading investors to speculate when a rate cut may occur.
Value stocks are currently priced as if the economy will deteriorate further than it actually will. If economic growth remains steady, company profits are likely to increase, resulting in a rise in the value of value stocks.
In summary, although value stocks have underperformed recently, it is believed that this trend will be short-lived. As investors look towards a potential rate cut and steady economic growth, the tide could soon turn in favor of value stocks.