Growth Stocks Still Outperforming Value Stock Rivals

Throughout the history of the stock market there have been clear cycles of growth stocks outperforming value stocks and vice versa. The two categories of companies rarely see a mix of some growth and some value outperforming other growth or value peers. It is very much a case of the groupings sticking together during their out and underperformance cycles.

Growth stocks are companies that, as the name suggests, are growing quickly. The big tech companies of FAANG are the perfect example. Their share price performance is based less on their current income and profit and more on what investors consider to be their future potential. Value stock are less fashionable companies that are usually well established, generate reliable income and profits but are mature and no longer growing quickly.

Since the recovery took hold following the financial crisis a decade ago, growth stocks have been the undoubted winners between the two groups. They’ve outperformed value stocks every single year since. Their popularity has been boosted by low interest rates and sluggish economic growth.

However, there are some signs that the value stocks might once again soon come into their own. This month long term yields on US bonds jumped. Higher yields on Federal Reserve bonds with maturity dates of longer than ten years means a fall in value of future cash flow. This historically hits equities but the sell-off that has been visible has been concentrated around high growth tech stocks. Does this mean the time has come for the portfolios of those investing online to finally shift capital allocation more towards value stocks?

A significant flight of capital from tech stocks would not only hit the sector but Wall Street and U.S. equities as a whole, which have become heavily weighted towards big tech over the last decade. That trend would be expected to result in capital hunting for a new home in Emerging Markets or value stocks in other developed markets such as those of Europe or Asia, like the UK and Japan.

Industrial stocks, carmakers and financial companies outside of the USA have all suffered recently from trade war and global growth concerns as well as negative interest rates in Europe and Japan. Companies in these sectors are traditionally value stocks. Over 75% of major listed international financial institutions have seen their share prices drop over 20% from their 12-month highs. The fact that non-U.S. equities have struggled of late also indicates a recession may not be as distant as many think.

However, some of these risks to growth stocks could fade if deals are reached on Brexit and Italy’s budget and China decided to inject some fiscal stimulus into its economy and financial markets. However, parallels can be drawn between today’s tech stock boom and the tech, media and telecoms bubble that popped in 2000. At the time, the Fed was also raising the base interest due to a heating economy and inflation concerns.

The popping of the dotcom bubble led to a period of value stocks outperformance. Investors, institutional and the retail equivalent of those investing online today moved into solid companies with strong balance sheets, steady markets and dividend payments. Neglected value stocks had come back into fashion and saw a boost in values as a result.

Big tech is currently considered a ‘crowded trade’, which means a high percentage of investors are increasing exposure to it. In fact, it’s been the most crowded investment sector for 9 consecutive months and a Merrill Lynch report also indicated tech is the sector most investment portfolios are overweight in.

However, those investing online right now still face a tricky decision. Momentum is still in favour of growth stocks and a shift towards value could prove early and mean missing out on the strong returns that tend to characterise the end of a cycle. Many respected analysts still believe that value stocks will only return to their own outperformance cycle following the next recession. So while there is no clearly right answer, it might still be too early to shift investment portfolio weighting significantly towards value.