“Stock markets’ response to news of the Pfizer vaccine trials has been to dash into recovery and cyclical stocks – ‘value’ names, for want of a better term – and away from the ‘growth’ stocks whose business models had seemed much more robust in the face of the pandemic and subsequent recession,” says Russ Mould, AJ Bell Investment Director.
“’Value’ has been quietly outperforming ‘growth’ since July, when tech and COVID-proof names were still supposedly the only game in town, and investors must now think hard about whether this will continue or not, as it could have a major impact upon the performance of their preferred stocks or funds,
“There are many ways to (crudely) measure how ‘value’ and ‘growth’ stocks are performing relative to each other but judging the relative performance of small caps against large caps is one way to do it. Two huge US-quoted exchange-traded funds make this quick and easy to do.
Source: Refinitiv data
“The Invesco QQQ Trust is designed to track the performance of the NASDAQ Composite’s index’s largest 100 non-financial companies and deliver that performance to investors, minus its running costs. The QQQ has $787 billion in assets under management and according to data from Lipper is the second-most traded ETF in the USA. Its biggest holdings are Apple, Microsoft, Amazon, Alphabet, Facebook and Tesla. It is therefore a good proxy for ‘growth’.
“In the opposite corner we have the iShares Russell 2000 Value ETF. It has nearly $8 billion of assets under management and follows a basket of nearly 1,500 stocks that offer ‘value’ characteristics. Two-thirds of the portfolio lies in the financials, industrials, consumer discretionary and real estate sectors – against barely 20% in the QQQ – and it has just 6% in technology, against 48% in the QQQ.
“Since the start of autumn 2014, when the NYSE FANG+ index was launched and the technology stocks and the FAAANM sextet of Facebook, Alphabet, Amazon, Apple, Netflix and Microsoft really began to come into its own, the Invesco QQQ is up by 183% and the iShares Russell 2000 Value ETF by 20%.
“Adulatory analysis of the second- and third-quarter results shown by the FAAANM names, among others, would lead you to believe that tech and ‘growth’ is still showing deadbeat, downtrodden cyclical and ‘value’ names a clean pair of heels.
“But not so fast. ‘Value’ names have surged this week, but they began to outperform back in July. This can be shown by dividing the price of the Invesco QQQ Trust by the price of the iShares Russell 2000 Value ETF.
“If the line goes up, the QQQ is outperforming and if it goes down then the ‘value’ tracker is outperforming.
Source: Refinitiv data
“The question now for investors is whether this is ‘it’ and the long-awaited return of value relative to growth or not. After all, ‘value’ beat ‘growth’ hands down from 2000 to 2007 as the tech, media and telecoms bubble collapsed and TMT stocks’ lofty valuations proved unsustainable. Tech and ‘growth’ began to gently assert themselves in the wake of the great financial crisis and really came into their own from 2014 onwards, since then they have really been almost the only game in town.”
Source: Refinitiv data
“However, even the most ardent growth fan may pause for thought when they see that the differential in performance between ‘growth’ and ‘value’, as defined by the Invesco QQQ and the iShares Russell 2000 Value ETF, is greater than it was even in 2000, at the tail end of the tech bubble.
“Thus may partly explain the violent outperformance of cyclicals and value names relative to growth plays post the Pfizer announcement and also why value has been stealthily outperforming since July.
“However, there have been failed rallies in value before – Q4 2019 was a recent example – so investors will now have to weigh up what could favour ‘value’ or ‘growth’ going forward.
“Valuation alone is never a catalyst for out- or –underperformance, but it is the single biggest determinant of long-term investment returns (and a decade seems like a suitable definition of long-term). If tech earnings keep growing and surprising on the upside, if interest rates stay low, if inflation stays subdued and the Facebooks and Apples of this world use the combination of product innovation and acquisitions to maintain and even deepen their powerful competitive advantages, then many investors will be tempted to dismiss valuation as an irrelevance and stick with ‘growth’.
“But the trouble could start if regulators begin to take a hand, earnings disappoint (as Big Tech does not prove to be immune to the pandemic after all or the law of large numbers means it simply becomes harder to generate strong percentage growth figures) or the wider economy starts to accelerate and inflation picks up.
“None seem likely now but that is why ‘growth’ has done so well relative to ‘value’.
“If a COVID-19 vaccine is quickly and successfully developed and distributed, then stocks which are seen as ‘immune’ from the pandemic may be less in demand and seen as less worthy of a premium valuation.
“Equally, if growth and inflation pick up, then investors may not be so inclined to pay such premium multiples for ‘growth’ companies, if rapid earnings increases can be acquired much more cheaply along downtrodden value, cyclical plays like industrials, financials and consumer discretionary plays.
“Moreover, an increase in inflation could force Government bond yields higher, even if central banks decline to raise interest rates and let inflation run hot, as per the US Federal Reserve’s new ‘average’ inflation target. This has been particularly noticeable this week, in the wake of Pfizer’s COVID vaccine trial, as the US 10-year Treasury yield has moved back toward 1% for the first time since March.
Source: Refinitiv data
“Prior periods of rising 10-year US Treasury yields have coincided with attempted rallies in ‘value’ names, so perhaps a return to economic growth and inflation could be the trigger for a sustained period of underperformance from ‘growth’ and ‘tech’ stocks relative to value ones.
“And while the concept of rising inflation may seem fanciful for now, investors should not forget that this is what central banks and Governments crave to help the globe manage its crushing debts, so they may stop at nothing until they get it. The latest money supply growth figures from the USA in particular are eye-popping and should be followed closely as a potential lead indicator.
Source: FRED – St. Louis Federal Reserve database
