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Spotting unexpected turns in the growth and value cycle

Matthew F. Beaudry

Matthew F. Beaudry
Senior Investment Director , 6/27/2017


  • Growth stocks tend to outperform in a slow growth environment; value stocks have historically outperformed as the economy is expanding.
  • While a diversified portfolio should include both growth and value, today’s valuations and economic conditions point to a value cycle.
  • While value cycles have historically spanned multiple years, it is not unusual to see periods of growth outperformance within the cycle.

The performance of growth and value equity styles tends to be oriented toward the economic cycle, making it possible to overweight a portfolio in favor of one style depending on economic conditions and outlook.

What may be counterintuitive to some investors is that growth stocks outperform in periods of slow economic growth or when the economy is decelerating. In such uncertain environments, investors seek out companies with more predictability of earnings. Investors have embraced stocks like Amazon, Facebook, and Google, which can grow in any environment, for that very reason. As a result, highly regarded growth stocks have escalated in price.

In fact, one of the longest periods of growth-stock outperformance on record occurred during the past decade, from 2007 through 2015. At eight years, this period eclipsed the previous growth market of six and a half years witnessed in the 1990s.

One consequence of this extended outperformance is that value stocks have become much more attractive relative to growth stocks.

Value-oriented periods can last a long time

At the beginning of 2016, I argued that growth stocks were too richly priced and value stocks were simply too cheap to ignore. The last time valuations diverged so greatly, value subsequently outperformed growth for the next eight to nine years. Such a span is not rare; when value outperforms, the cycle has historically spanned multiple years.

The recent growth outperformance might not last

It’s important to note that value cycles can be interrupted by brief growth outperformance. As an example, in the first half of 2017, growth has outperformed value.

Investors skeptical of future economic growth and of the ability of the Trump administration to pass its proposed legislation opted for the greater predictability of earnings from growth stocks in an increasingly uncertain environment. Such sentiment is also observable in the yield curve, which has begun to flatten — typically a positive indicator for growth equities. In contrast, a steeper yield curve is especially positive for financials, the greatest sector overweight in value stocks, and thus would be an encouraging indicator for a value market.

Value stocks may have an advantage

Despite negative sentiment, much of the data points to continued and accelerated economic expansion going forward. When the economy is expanding, earnings tend to grow across the market and in such an environment, investors historically could purchase value cyclical stocks at a much more attractive price than evergreen growth stocks. As a result, an opportunity for investors to buy value remains in place.

Equity allocation is not a binary decision, and a diversified portfolio should include both growth and value. However, history, valuations, and the economic backdrop would suggest an environment in which value stocks could reassert their outperformance, like we witnessed in 2016.

Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell®is a trademark of Frank Russell Company.

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