Value Stock Rally: More Profits to Come?
Dear Rich Lifer,
Until recently, growth stocks drove stock market gains for a decade…
But that wasn’t always the case. In fact, historically, value stocks have outperformed.
The debate of whether one type of investing is better than the other has raged for years.
Those who advocate for value point out the success of “buying low” and watching their investment grow over time.
Those who rally behind growth stocks point out that the returns from higher-priced stocks come in faster. Rapidly growing companies tend to reinvest their cash back into the business; thus, investors can expect capital appreciation or higher stock prices.
What’s the market currently telling us about which investment strategy is the best right now?
Let’s take a look…
The Value Stock Rally
Value stocks have been the big winner of the past year, but is the rally going to last?
Even though we saw growth stocks try to make a comeback — from June 4 to June 18, the iShares S&P 500 Value ETF declined 5%, and the iShares S&P 500 Growth ETF gained 1.5% — it appears that the dominance of value stocks is here to stay.
Keith Lerner, chief market strategist at Truist Advisory Services, calls the recent rollback in value stock an “uncomfortable gut check for the value trade after it became overcrowded on a short-term basis and vulnerable to a setback given hefty gains over the past nine months.”
But he went on to confirm that “the factors behind our value tilt have not changed.”
So what are these factors?
Lerner says that the U.S. economy will grow almost 7% this year and over 3.5% next year. That would continue to drive stronger earnings growth for the cyclical areas of the market that consist of much of the value basket.
He also forecasts long-term rates to climb higher in the second half of the year and the yield curve to steepen again as the global economic recovery picks up. Higher interest rates would discount growth stocks’ future cash flow even more and make them appear less attractive.
The Future of Growth Stocks
That all might lead one to expect rough waters ahead or growth. But some strategists are anticipating slightly less dire circumstances.
Citi strategist Tobias Levkovich envisions a better environment for growth stocks later this year and going into 2022. He believes that by that time, some of the current supply shortages might have eased, which would result in prices cooling down.
He explained, “that alone could take the pressure off the valuation concerns around higher-growth stocks, where much of the prices are a function of terminal values determined by discount rates.”
Levkovich further muses that if the robust economic recovery continues, value companies could have a hard time continually meeting Wall Street expectations in the future.
But for now, the general consensus is that value stocks will lead the markets for the rest of the year.
Because this trend is set to continue, many advocates of active management are advising that index funds should be avoided…
Are Index Funds Beating Actively Managed Funds?
Index funds are coming out on top of actively managed funds.
But we should take a look at why champions of active management are fighting this narrative.
History shows us that many more value funds beat the S&P 500 Index when value is supreme than during such periods than when growth is beating value.
Take a look at the 500 or so actively managed open-end mutual funds that Morningstar Direct classifies as in the value camp.
Mark Hulbert reports for Barron’s:
Since the end of last August, which is when value began its recent outperformance, virtually all of them — some 95% — have beaten the S&P 500. During the prior five years, during which growth far outpaced value, hardly any of these value funds (fewer than 1%) beat the S&P 500.
However, while this is an interesting trend, it doesn’t support the stock-picking narrative because the S&P 500 is an inappropriate benchmark for judging the performance of a value mutual fund.
This index, as many of you may know, is largely made up of large-cap growth stocks, so comparing value fund managers to it tells you nothing about their stock-picking abilities.
The biggest names in the S&P 500 are companies like Facebook, Amazon and Apple, but all these tech giants are traditional growth companies.
The proper benchmark for judging the stock-picking abilities of a value manager is an index containing value stocks.
At the end of the day, if you want to invest in value stocks, the obvious choice is to invest in an index fund.
The actual decision will be whether you want to invest in funds that focus on large-, mid-, or small-caps and find index funds that match your goals.
To a Richer Life,
The Rich Life Roadmap Team