Cover story – The great rotation
effective approach – and could well form the investing model for years to come. Yet placed in a more recent timeframe, value investors have experienced lowly returns since the financial crisis, with the trend of outperformance for growth stocks, e-commerce and other technology companies further accelerating up to 2020. Put simply, during the past decade, the Russell 1000 Growth index has returned 17% annually, while the Russell 1000 Value index grew by 10% – a stark difference.
All this though is down to context. In the wake of the calami- tous events of 2008/09, the low interest-rate environment cre- ated by central banks encouraged tech companies to use debt to drive growth. This model of massive investment to grow scale and eventually deliver returns attracted investors to go for ‘growth’ despite companies potentially running losses for years. Nevertheless, Amazon and Facebook are tech giants that have proved it is possible to deliver profits. Another example is the S&P500 Growth index – heavily weight- ed to the technology sector – which delivered an annualised return of 15.8% in the past decade and by contrast, the value index – geared toward financials, healthcare and industrials stocks – lagged at 10.9%. Two points can be made here. First, the large tech names that have boosted the growth indexes by delivering amazing num- bers in recent years, raises a big question over whether such returns can be replicated in the coming years. Secondly, with financials being a large part of the value indexes, and technology stocks making up the largest part of the growth indexes, much of the underperformance of value stocks since 2007 can be attributed to the devastating impact of the great financial crisis and the low interest rate environment that con- tinued in its aftermath. “With the benefit of hindsight, it’s no surprise that financials have struggled to keep pace with the biggest tech stocks since 2007,” says Michael Bell, a global market strategist.
Stretched valuations
Therefore, putting the argument back in favour of value, price discrepancies between growth and value have reached extreme levels. “One consequence of a decade of growth outper- formance is that valuations are now stretched to levels that would have historically foreshadowed negative returns relative to value,” a researcher at one asset manager noted. For example, US growth stocks trade at 52 times their cycli- cally adjusted historical earnings compared to 21 times for value stocks. That makes them the most expensive they have been, in relative terms, since the dotcom bubble around 20 years ago. Yet in 2011, and again five years later, growth stocks traded at a lower premium to value stocks, but valuations are less support-
20 | portfolio institutional | May 2021 | issue 103
ive today meaning that a sustained value rally is much more likely than ever before.
What many market observers expect to happen is something akin to the crash of the popular so called “nifty fifty” stocks in the 1970s or the bursting of the dot-com bubble in 2000. The tech bubble that popped at the turn of the century was, it should be noted, followed by a rotation into value stocks. That lasted from 2004 until 2008, at which time banks and other lenders were destroyed by the financial crisis. The issue is that irrational exuberance by investors led to growth stocks being considered by many to be overpriced. It did not stay this way. Prices reverted to the historical mean of their performance, so investors should expect a correction.
Investor appetite
And this appears to be happening. Investors look to be turning away from the technology stocks that fueled a decade long eq- uity boom, as the aforementioned trends encourage a shift from growth into value stocks. The S&P500 Value index – made up of the top 100 S&P500 stocks deemed to be cheapest on price-to-book, price-to-earn- ings and sales-to-price ratios – has returned 8.6% in 2021, more than four times greater than the 2% gain recorded by the broader S&P500 index. By contrast, the S&P500 Growth index, dominated by tech be- hemoths Apple, Microsoft, Amazon, Facebook and Alphabet declined by 3.8% during the same period. The turnaround in investor appetite looks unambiguous. To further illustrate the point, BlackRock’s $14bn (£10bn) iShares MSCI USA Value Factor ETF has soared almost 40%
Investors now seem a little wary of jam tomorrow growth stocks and seem to be preferring jam today
companies. Russ Mould, AJ Bell
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