The Start of Something Big When a Lovely Thing Dies?

October 12, 2020

The classic dichotomy of growth stocks versus value stocks may be at a pivot point.

The classic dichotomy of growth stocks versus value stocks may be at a pivot point.

If it is, the resultant scenario might soon be summed up with these hybridized song lyrics: When a lovely thing (growth’s long run) dies, it could be the start of something big (value rising from something small).

Value stocks are, of course, scoffed and shunned, which is what makes them undervalued by investors despite inherently promising fundamentals. They are companies with share prices below those of the broader market and below those of their industry peers.

By contrast, growth stocks are priced higher than the broader market, have recent high earnings growth and exhibit relatively high volatility—meaning more risk.

Growth has had a long run triumphing over value, stretching for more than a decade this time around. But historically, value has had some long runs, too, shining again after high-flying growth stocks have receded.

As personified value stocks would say to preening growth stocks, pride goeth before a fall. And historically, when growth stocks have fallen, value stocks have stepped over them and thrived.

Over periods of 10 to 15 years, growth and value have historically averaged about the same returns. Over shorter periods, though, historically there have been significant differences.

The current dominance of growth is an unusually long run. But now that the overall market has come down a bit from its lofty highs several weeks back, the decompression is greater for growth stocks—in September, down about 10%, compared with 5% for value stocks.

The long run

A study by Dr. Kenneth French at Dartmouth’s Tuck School of Business shows that over the really long term, value has done far better.

In this study, a centenarian’s hypothetical, $1 invested in value index shares purchased in 1927 would now be worth more than $50,000. During the same period, a dollar invested in growth by now would have grown to just under $3,000.

Over shorter periods, of course, results vary according to whether we’re in a growth or value cycle.

Until recently—and even still in some quarters--talking about near-term prospects for value outperforming growth has been like worshipping false gods.

However, a few analysts and prominent economist (Jeremy Siegel of Wharton) has been poking his/her head up recently to point out signs of a coming market rotation from growth to value. And some investment houses have recently announced a new emphasis on acquiring value shares.

Historically, the best time to add value shares to a portfolio has been when they were doing the worst relative to growth—when the spread between the two has been the widest. In recent weeks, these spreads have been quite wide.

The disparity is illustrated by the difference in performance between the value ETF SPYV, down more than 10% for the year, and the growth ETF from the same company, SPYG, up more than 17%, as of late September.

Yet, as value-to-growth spreads were narrowing a couple months ago, before widening again, this apparently prompted some tech-growth-skittish investors to start adding value shares. While value stocks by no means are showing a jackrabbit start, these investors evidently anticipate a sustained uptrend, as value is getting big cash inflows.

Early signs of rotation?

In the first two and a half weeks of September, for example, nearly $900 million flowed into the iShares MSCI USA Value Factor ETF (VLUE), with other value ETFs also getting noticed by a previously indifferent market.

This shift is also evident on the other end of the growth-value see-saw, with declining numbers in some big growth funds.

Invesco QQQ Trust (QQQ), which has benefitted from the growth feeding frenzy this year through large allocation to big tech growth, saw $1 billion leave in the first two weeks of September. Other prominent growth ETFs have experienced the same recent fate.

Investors selling growth and adding value are apparently positioning for what they expect to be a near-term rotation. If this rotation is slow in gaining steam, at least they’ll be diversified, fortified against a big growth drop in growth stocks.

And there’s another benefit to being in value now. With bond yields scraping bottom, choosing the right value stocks can not only position you for growth in the event of a grand rotation, but also can bring higher income. 

Supplanting bonds with stocks

Adding the right values stocks in lieu of bonds needn’t play havoc with your asset allocation as it used to, as asset-class dynamics have changed.

The classic 60-40 percent allocation of stocks to bonds —your father’s asset allocation (switching to 60-40 close to retirement)—is archaic now that bonds’ performance is more correlated with that of stocks and bond yields are paltry. Bonds now offer the worst of both worlds--a fixed term with almost no income.

The right value stocks are those that, while not big growers, aren’t big sinkers, either. Some, like 3M and Caterpillar, have exhibited relative price stability over long periods.

Add to that a reliably paid dividend and a good dividend yield (price per share divided by annual dividend—essentially, what investors have to pay for dividends), and you have a stock that serves goals of owning bonds, but with better income.

Some value stock dividends are far superior to bond income now that Treasury yields have sunk well below 1%, with the 10-year paying .753% and the 5 year, .318% on Oct. 5.

Yields of investment grade corporate bonds are also a shadow of their former selves. As of Oct. 2, the yield to maturity of the iShares Core US Bond ETF was 1.14%.

By contrast, the current average dividend yield of dividend aristocrats—a category of 50-plus venerable, long-established companies in which 3M and Caterpillar are charter members--is 2.3%.

Dividend aristocrats have:

  • A record of increasing dividends every year for at least 25 years.
  • Lower-than-average price volatility.
  • A record of holding their value over rolling five-year periods. The aristocrats haven’t had a negative five-year period since 2000—even in the financial crisis of 2008-09.

Despite the current defensive—and potentially offensive—advantages of getting into aristocratic value stocks, there are good reasons to believe that some big tech stocks—despite high prices and sky-high price/earnings ratios—will nevertheless continue to do well, though probably without ethereal ascendance they showed in Q2 and Q3 of this year.

For example, the semiconductor industry will continue to thrive, selling chips to data centers and electric car manufacturers, whether or not many people are still working from home.

Thus, tech growth companies with sustainable business models and reliable earnings will continue to fertilize the economic ground for value companies. Investors in this ecosystem may want to own stocks or funds, in the right amount, in both the value and growth categories. 

David Sheaff Gilreath, a certified financial planner, is a 39-year veteran of the financial service industry. He established Sheaff Brock Investment Advisors LLC, a portfolio management company based in Indianapolis, with partner Ron Brock in 2001. The firm manages over $1 billion in assets nationwide.