Why Isn’t It Working?
Have you ever seen the old Popeye cartoons?
If you have, then you know there was a certain vegetable that gave Popeye super strength as soon as he ate a can of it. That’s right, spinach.
He would eat that can of spinach and his muscles would immediately get bigger and he would suddenly be able to defeat his arch enemy Bluto and rescue his true love Olive Oyl.
So as a four-year-old kid I tried some canned spinach. And, needless to say, the results were rather disappointing. My muscles didn’t bulge. I didn’t feel invincible. And it tasted awful.
My disappointing spinach experiment as a kid is comparable what many value investors feel like lately. They’ve been doing what they thought was the right thing and the immediate results have been less than stellar.
Recent History Belongs to Growth
In the past several years large cap growth stocks have substantially outperformed large cap value stocks. In fact, in the three most recent calendar years (2017-2019), the Russell 1000® Growth Index has outperformed the Russell 1000® Value Index by amazing 10.81%. That also brings the 5-year outperformance to 6.34% and the 10-year outperformance to 3.42% (Source: FTSE Russell Index Calculator at https://indexcalculator.ftserussell.com/).
There is no doubt that investors with recent large cap growth exposure have benefited from that outperformance. But the key question for investors going forward is, are you more likely to benefit from a portfolio weighted towards growth or towards value?
That is the focus of this article. And (spoiler alert) in my opinion, over the long run, investors are more likely to benefit from overweighting large cap value than large cap growth.
Reasons Value is Likely to Outperform Growth Again
That’s right. I’m taking a stand right now.
I’m declaring that in the future, value stocks are likely to outperform growth stocks. So remember this moment. Remember who told you.
And if in five, ten or twenty years from now value has outperformed growth, please give me all the credit I deserve for making the prediction.
And how much credit would I deserve? Actually, not has much as you’d think.
Markets are Cyclical
Here’s the deal. There are two reasons why I am comfortable taking a public stand for team value. First, the market’s preference for value or growth has historically been fairly cyclical. In other words, periods of growth outperforming value tend to be followed by periods of value outperforming growth and vice versa.
For example, from 1999 through 2009, value stocks outperformed growth stocks by a whopping 6.46% (Source: FTSE Russell Index Calculator at https://indexcalculator.ftserussell.com/).
So predicting that “in the future” the market will once again favor value is not a particularly bold prognostication. It’s basically predicting that the market will continue to ebb and flow.
However, there’s an even better reason I believe that value will once again outperform growth and that is because…
…Value Stocks Usually Do Beat Growth Stocks.
That’s right. Just as stocks tend to beat bonds over long periods of time, value stocks tend to beat growth stocks over similar periods of time. For example, for any 10-year time frame since 1928, value stocks outperformed growth stocks 83% of the time (Source: Dimensional Funds, “A Perspective on the Value Premium” by Kevin Green, PhD, 02/19/2020. Value outperformance defined as the Fama/French US Value Research Index minus the Fama/French US Growth Research Index.).
To put that in perspective, stocks outperformed the one-month US Treasury Bill 85% of the time (Source: Dimensional Funds, “A Perspective on the Value Premium” by Kevin Green, PhD, 02/19/2020. Stock outperformance defined as the Fama/French US Value Research Index minus the One-Month US Treasury Bill). This means that over 10-year periods, stocks are only slightly more likely to beat bonds than value stocks are likely to beat growth stocks.
So, all things being equal, in any given 10-year period value stocks are more likely to beat growth stocks than the other way around. And the same is true for 5-year periods as well.
Proceed with Caution
However, one should exercise caution in implementing this strategy because growth stocks could still continue to outperform value stocks for years to come. In fact, although value does tend to beat growth over time, research has also shown there is no way to use this information to accurately time a profitable value trade.
In other words, even though I remain firm in my conviction that there will eventually be a strong market shift from growth to value, there is nothing to indicate that this is the absolute best time to start selling growth stocks and buying value stocks. The best time to do so may have been last year or it may be five years (or more) from now.
So What Should You Do
If your portfolio is over weighted to growth stocks, this is a great time to discuss with your advisor how much value stock exposure you should have in your portfolio. But keep these points in mind:
- Value stocks are by nature riskier that growth stocks
- A well-diversified portfolio will likely be comprised of both growth and value companies
- Overweighting in value stocks means your portfolio performance will vary more greatly (for better or worse) from the performance of an equally weighted growth and value portfolio (such as the S&P 500 index)
Important Disclosure: Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs and expenses. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results.