Rotation Out of Growth – Is this ending or only the beginning?
Investors have been rotating aggressively out of Growth stocks to other sectors and Value stocks recently. Is this going to continue? The most often compared strategy pits Growth against Value, so in this note we will compare how Value stocks have done versus Growth.
Growth stocks have outperformed Value stocks for over 14 years (since Dec 2006), the longest stretch I have on record.
Chart 1: Growth vs Value since 1990 (Wilshire US Large-Cap Growth Index over Value Index)
Recently, Value stocks have staged a remarkable comeback, on the back of an expected economic recovery linked to mass vaccinations. Is this the start of a bigger trend where Value outperforms Growth?
Chart 2: Growth vs Value since 2020 (Wilshire US Large-Cap Growth Index over Value Index)
Let’s examine significant recent developments in the Growth and Value stocks front.
Ark Funds have been the flagbearer in recent years for Growth stocks. Ark openly sharing their stock holdings on a daily basis have resulted in many investors trying to replicate their strategies by selectively picking stocks within Ark ETFs that matched their own preferences. This “selective replication” indirectly supported Ark’s ETF prices when growth is in vogue. However, as the market rotated out of growth, the real-time sharing of positions has worked against Ark, as these same investors and other speculative players are quick to sell their stocks first, resulting in outsized moves for many top stocks listed under Ark’s ETFs, and further exaggerating Growth stocks’ demise.
Unlike the last dotcom rally that resulted in a bust in early 2000 (see the peak of Chart 1), there is little argument this time that most growth stocks, especially the large cap, have risen on the back of strong top and bottom lines growth. However, not many would disagree that growth stocks have rallied to expensive levels, prior to this rotation. This correction in growth stocks is thus a healthy one to correct excesses, especially those not supported by sound fundamentals.
The rapid rise in US 10-year yields have been cited also as reason to sell Growth, as higher rates would cause a larger fall in valuation for growth companies due to their higher proportion of future earnings.
Chart 3: US 10-Year Yield
However, note that Value companies will see FALL in valuations too, due to the effect of higher rates on future cashflows, irrespective of the size of their future earnings. Perhaps with the exception of banks, most Value stocks do not gain from a rise in yields. Thus, arguing the rotation from Growth to Value on this reason isn’t convincing to me.
The rise in US 10-year yields is likely due to one or both of these reasons – inflation and growth. Inflation is forecasted to be above 2%. GDP growth will clearly be much higher too due to the low base of 2020. Inflation is a virtual certainty, due to fiscal support (read: money printing) not just from the US government, but from major economies globally. I have no doubt that inflation is on the way up, and asset inflation is likely to follow. Bridgewater’s Ray Dalio suggests that “cash is trash” and that we should “buy stuff – any stuff”.
That leads to one obvious question – which asset(s) to buy?
Assets outside equities is outside the scope of this note.
Come to me privately and I will share my candid response with you
Staying on equities, it is a fact that equities always trend higher in the long run, and I think it is no different this time. Growth stocks have corrected some excesses in this rotation, but it’s far from cheap. Value stocks have underperformed for the longest time and only recently got its day in the sun, so they are now much better valued now and not necessarily cheap. When we refer to Value stocks, we have to be more discerning and sector/industry specific as not all are affected in the same way in this pandemic. Without going into specific sectors, I would just suggest generally that markets seldom correct only to “fair valuation” but tend to overshoot. As many Value stocks are still slightly lower than their Jan 2020 levels, it might suggest that this “rotation” might continue just a bit more.
Your next obvious question – Is the rotation out of Growth ending? If not, when?
There is no doubt in my mind that in the Industry 4.0 revolution we are in, innovative companies will be the biggest winners. Growth companies would continue to outperform, at the expense of resistant/slow-to-change Value companies. Having said that, many Value companies are learning quickly and are adapting/pivoting, and they will gradually be rewarded with stock price appreciation and move out of the “Value” list. Clearly, these adaptable Value companies will continue to outperform the slow-to-change Value companies.
Take a look at Charts 1 and 2 again, can you tell if this is the start of a bigger Value over Growth trend or merely a blip before Growth reasserts itself? I won’t bet on it. Rather than asking how long this rotation will last, the secret in my view is to have exposure to both deserving Growth and Value companies. To be more specific, having exposure to improving top AND bottom lines Growth companies, and adaptable Value companies. My preference has been to be exposed to both types at ALL times, but tweak the weights tactically depending on your own investment personality and prevailing factors. In fact, I would also have high Yield stocks in my portfolio to provide diversification and income support. If you want a more comprehensive explanation on how I structure my portfolio, I will direct you to my book “Personality Driven Portfolio”, which you can find here.
In the 2 funds I manage for Dios Asset Management, we’ve exposure to stocks belonging to all three strategies of Growth, Value and Yield. This diversification has served the funds well in that it has weathered the volatility much better than a pure Growth fund had, while providing returns much better than a pure Value fund would. I wish I knew ahead of time to switch from Growth to Value, and vice versa. But let’s be honest with ourselves, how many of us can make the right switching calls consistently over the years? I tune Growth stocks down in early March, and added Financials and Value stocks, but otherwise the allocation is largely unchanged. So let me reiterate, if it is still not abundantly clear by now, the answer is not about having one or the other, but about having the right exposures to BOTH Growth and Value (and Yield too)!
P/S: While diversification has served us relatively well this round, I do not intend to stay still and do nothing. We can always strive to do better, and we must, as the markets do not stand still. Call it rotation or otherwise, this correction in Growth stocks is an opportunity. Over the next couple of months, I will be fine-tuning to further improve the returns of the funds, stay tuned!
Chief Investment Officer
Dios Asset Management