Value vs. Growth - The Great Debate

We have seen a historic out-performance of growth over value equity styles over the past number of years. Most recently a sharp correction in the growth and technology space lead to questions around a sustained value rebound. Many investors are asking what comes next, is it time to rotate out of growth and is it even worth trying to time equity factor performance?

WHAT’S DRIVING THIS TREND?

In an environment of low interest rates and low growth, investors are willing to pay premium for companies that can deliver significant earnings growth. This of course describes the post-credit crisis environment and explains one of the reasons why growth outperformed since then.

Value stocks, on the other hand, are often stocks of cyclical industries. These tend to do well in a more robust economic environment, which we have not really seen recently – despite the unprecedented market run up, global economies have been growing as sub-par rates.

Sector composition is an important consideration too, as we can see in chart below.

As an example, a bet on growth equity could be looked at as a bet on technology, because tech stocks have such a high weight in the growth index. The environment has been very good for technology, especially with the COVID outbreak that forced consumers online.

On the other hand, a bet on value is somewhat a bet on financials. The 2008/2009 financial crisis was followed by increased regulation, low and falling interest rates, and a flatter yield curves. It is no surprise that financial stocks have struggled.

Consequently, sector exposures within the two equity styles have had a large impact on their relative performance.

FACTOR TIMING – IS IT EVEN WORTH IT?

It is very difficult to time factor performance. A better strategy, in our view, is to have a diversified factor exposure within your portfolio. We believe a strategy that allocates strategically to complimentary factors from a correlation perspective (quality, value, and momentum for example) works better over the long-term.

In our portfolios, we do not have large exposures to any one equity factor or style in particular. Rather, we follow a more diversified approach to targeting various complementary factors. We dynamically tilt towards or away from certain factors at the margin, based on our forward-looking views.

CASE FOR VALUE

Value out-performance is tied to the fortunes of a global economic re-acceleration. There could well be substantial pent-up demand that is ready to be unleashed on medical advancements related to COVID. Couple that with huge amounts of monetary and fiscal stimulus, there is tinder for a more robust economic recovery.

A potentially weaker USD would be a tail wind for other ‘value’ sectors such as industrials, basic materials, and energy. Valuations for value stocks are also at historic lows and although not a great timing tool, this is also a tail wind.

CASE FOR GROWTH

Growth, which is heavily driven by technology, is well set up for post-COVID acceleration of already existing trends (mobility, data, robotics, online) along with the emergence of working from home and social distancing trends. If the economic bounce fades to a slower growth environment, all else equal this would favor growth.

Although expensive from a valuation perspective, earnings and return on equity for growth are robust, especially compared to value. The liquidity backdrop with low real rates will likely persist or even improve further, which could support growth valuations to go even higher.

WHERE WE STAND

The recent rout in the technology is concerning but in our view was driven by more technical factors in the options market. Technology does face some political risk going forward but we think the bark may be bigger than the bite. Value is cheap but potentially lacks a catalyst for sustained out-performance. The question remains, what to do?

We are fairly neutral value vs. growth with a slight tilt towards growth in our portfolios. We are cautious on the prospects of a V-shaped economic recovery and do not see value stocks sustainably outperforming outside of shorter fits and starts. COVID and even post-COVID trends seem to favour more growth-oriented sectors. However, a large valuation gap favoring value is a concern. Thus, on balance we are not aggressive in our current equity factor positioning.

In our portfolios, we had taken some profits in some of our more tech/growth-oriented managers with slight reductions in their allocations into more core exposures. We still believe growth can work and remain slightly overweight but are leery of being too over our skis in the trade from here.

Comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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