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Peter Hardy, senior client portfolio manager, global value equities, American Century Investments.
The basic tenet behind value investing — buying a less expensive asset on the basis of their financial productivity is better than buying an expensive asset — hasn’t changed. Is value poised for outperformance and are the fortunes set to change? Yes. When, is the question. Over the last 10 years in an incredibly accommodated monetary policy environment, growth stocks have outperformed value stocks.
There are reasons for some of the outperformance. Growth stocks are beneficiaries of low interest rates, greater beneficiaries than value stocks as their earnings are further out in the future, so lower interest rates help them. Their earnings have been better from a fundamental standpoint. And sitting today at the beginning of 2021, growth as a style has outperformed value by its widest margin in history. In 2020, growth outperformed value on the Russell 1000 growth versus value by about 35% creating the widest gap in performance on the styles for a one, three, five and 10 year basis.
Additionally, the outperformance of growth — basically growth has beaten value since 2009 — is the longest period of sustained style outperformance in history. All of this says now is not the time to load the boat on growth stock and investors should ensure that they have exposure to value from a risk-return perspective. The timing we don’t know. Value versus growth is cyclical over time. But what we do know is when value reverts, it can revert violently and investors need to have exposure there.
The spread on performance, and the difference in the valuations between growth and value are similar to the tech bubble in ’99, 2000. And when value started outperforming in the spring of 2000, it was a reversion and it occurred without any corresponding catalyst. Growth stocks just started underperforming in 2000 under the weight of their high expectations and high, high valuations.
There are several catalysts for reversion as we sit here in January 2021. The first is, improvement in economic activity due to Covid improvements and stimulus. And this is specifically where the new Biden administration is a catalyst. Covid has been the specific cause of economic malaise and is the greatest risk to worldwide economic growth. The Biden administration has made Covid and vaccinations its top priority and getting past the ill effects of Covid will result in the normalization of economic activity. The normalization of economic activity provides greater benefits to value stocks. Also, the Biden administration has focused on extending stimulus. A $1.9 trillion stimulus package is in play, and the broad economic benefits of stimulus provide outside benefits to value stocks.
The second catalyst to reversion would be a more normalized yield curve and lower loan losses. Banks are larger components of value benchmarks versus growth benchmarks. Broader economic growth should lead to a more normalized yield curve and that’s an environment where bank earnings accelerate and value stocks should be greater beneficiaries of that versus growth.
Additionally, all of the stimulus that has been in place has lessened the pain of Covid and you’ve seen loan losses for banks coming in below expectation. That has enabled banks to release reserves that they took to account for losses and gives them the ability to increase dividends and stock buy-backs on a forward looking basis.
The third catalyst for reversion for value would be housing sector strength. The strength from the housing market has been one of the most surprising outcomes of Covid. We’re at historically low levels of housing supply in the U.S. so this housing strength is expected to continue. And housing provides massive benefits to value in that your more old economy stocks reside on value benchmarks, and therefore housing strength has greater benefits to value stocks.
The last catalyst would be moderating relative expectations for growth stocks. One of the reasons that growth stocks had beaten value stocks over the last several years is that their earnings growth have been better. The broadening of economic growth is actually leading to a reversal in that trend. Value sectors now have higher earnings expectations based on kind of broadening of economic growth versus growth sectors. For instance, the financial sector is expected to grow earnings 42% through 2022, while technology stocks are only expected to grow 34% — I say “only” jokingly. But banks have substantially lower valuations and higher expectations for earning, which could be another catalyst for reversion.