Value Stocks as Laggards? Not Anymore!
- By John Tierney
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- 6 min read
Summary
- Many investors may be surprised to learn value has outperformed growth and tech since the March 2020 market low.
- The growth-value theme will likely persist, so we discuss positioning strategies.
- Growth versus value investing only makes sense in the large-cap sector. The small caps are more about their broad sector valuations and prospects versus large caps.
- Many value stock ETFs include growth stocks, missing the full performance range of pure value stocks. Investors should focus on pure value ETFs.
Market Implications
- We like the large-cap value sector. Investors focused on medium-term fundamentals should overweight the RPV ETF and underweight or short the RPG ETF.
- With earnings season upon us, the growth and tech sector may recover year-to-date losses and outperform value in the short term.
- Technical-oriented investors should consider reducing value positions and holding the QQQ or SPYG ETF. As earnings season peaks, rotate back into value.
The 2022 equity market narrative so far has been primarily about the rotation from growth to value. Year to date, large-cap growth is down 6.6% and value up 4.9%. Is there still juice in this trade? And how do you play it, apart from buying and selling hundreds of individual stocks?
Do Not Look to Traditional Sectors for Growth versus Value Trades
For starters, let us look at what growth versus value is not. The standard equity sector breakdown – consumer discretionary, energy, financials, etc. – is unhelpful. When we subdivide the S&P 500 by sector then growth versus value, the only pure growth sector is information technology. The pure value sectors are communications, consumer staples and utilities (Chart 1). The other sectors are a roughly 50/50 blend.
On performance, the only sector that followed the growth -value theme was information technology, with negative returns. Communications and utilities posted negative returns, and consumer staples was essentially flat. The best-performing sectors by far were energy and financials, which are a blend of growth/value. Energy gained on a 9.6% jump in oil price, and financials gained on perceptions that higher rates will benefit banks.
The takeaway is that traditional sectors are no way to trade growth versus value. And more is happening in today’s market than just growth versus value.
Growth and Value ETFs Differ Greatly
There are various ETFs constructed to represent the growth and value sectors. For our purposes, they fall into two basic groups: ETFs that track well-known indices, and more focused ETFs.
S&P has three standard indices for the US market – the large-cap S&P 500, the mid-cap S&P 400, and the small-cap S&P 600. These are subdivided into growth and value sectors, with each stock in the index allocated to one or the other. For some reason, the value sector includes various stocks that are also in the growth sector. For example, the S&P 500 growth index has 240 stocks – and the value sector has 450 stocks.
ETFs that track these indices follow this convention. For example, State Street Global Advisors has a family of ETFs that track these indices (Table 1).
Invesco has more focused ETFs. Its large-cap growth ETF has 241 stocks (like the index). But the value ETF only has 124 stocks, excluding about 30% of the S&P 500.
These structural features significantly impact their relative performance. In the growth sector, the SPX growth index tracker (SPYG) closely tracks the pure growth RPG ETF (Chart 3a). However, investors seriously interested in growth would do better with the NASDAQ 100 tracker, QQQ.
The value sector is a different story. The pure value ETF (RPV) has varied far more than the SPX value tracker SPYV (Chart 3b). Before the Covid crash, SPYV closely tracked the SPY (which tracks the S&P 500) due to its growth stock exposure, while RPV lagged. After the election, RPV rallied much more than SPYV. In the 2022 rotation, RPV outperformed SPYV by 2.9 percentage points.
Investors interested in growth can choose between the tech-oriented QQQ or the broader-based SPG or RPG. On the value side, we cannot recommend ETFs that track the SPX value index – it is not a pure value index, and its performance characteristics are ambiguous.
Growth versus Value Is a Large-Cap Strategy
The S&P mid-cap and small-cap indices also have growth and value subsectors. The recent rotation indicates their relative performance well (Table 1). Focusing on the last column, the large-cap pure value outperformed pure growth by 9.2 percentage points. The difference for midcaps and small caps was 5.6 and 4.9 percentage points, respectively. The differential was smaller for the SPX-related indices due to the smaller returns in the less pure value sector.
This is just a snapshot, but it represents the different relative performance of growth versus value trades across sectors. The large-cap sector tends to generate more volatility and better returns (but also higher risk if you are wrong).
In general, we recommend focusing on the large caps for growth versus value strategies. The smaller-cap sectors are more suited for broader large-cap versus smaller-cap strategies.
Value Is the Clear Pandemic Winner
With so much focus on the turbo-charged tech sector (and various meme stocks) throughout the pandemic, it is remarkable that the strongest performer since the March 2020 bottom has been the pure large-cap value sector (Chart 4, green line). RPG and QQQ were neck and neck with RPV at yearend 2020, but the 2022 rotation put value firmly on top. Notably, the blended SPYV ETF has done poorly.
Much of this relative performance is tied to the starting point – pure value started from a weaker place and had more upside.
Sometimes, tortoises really do beat hares!
Does the Value Trade Have Legs?
After a big move, there is a natural inclination to rebalance positions. We make two points.
First, value tends to be a momentum trade. It tends to out- or under-perform for extended periods. Looking ahead into 2022, the factors that led to the rotation – rising interest rates, a strong labour market, a possible return to more normal lives and consumption patterns, and growing regulatory pressure on big tech – all indicate further gains for value, especially as supply-chain issues are resolved. Granted, we are not looking for another dramatic shift like the first week of 2022.
Based on fundamentals, we suggest maintaining or adding to value positions.
That said, 4Q earnings season is upon us. Earnings will likely continue 2021 patterns – strong tech earnings, solid margins at many companies, and more value companies mentioning supply-chain problems.
In this scenario, we expect the growth sector and tech in particular could largely recover year-to-date losses and outperform value in the short run.
More trading-oriented investors should consider rotating back into the growth/tech sector during earnings season, then re-establish value positions as earning peak or run their course.
Concluding Remarks
We have focused primarily on the SPX-related indices. There are also growth/value ETFs on the Russell 1000 and 2000 indices, and the MSCI indices. Our conclusion that large caps is the better place for growth versus value strategies holds for these other indices.
Also, investors interested in these indices should check whether ETFs are structured with a pure or blended exposure. For example, the Blackrock iShares Russell 2000 growth (IWO) and value (IWN) ETFs have 1,246 and 1,447 holdings, respectively, or 2,693 total – well above 2,000.
We like large-cap value as a 2022 trade. With earnings season coming, we favour growth/tech as a shorter-term holding.