Does the resurgence of value stocks over growth stocks mean the days of the bull market are numbered?
I’m referring to the epic battle between two major stock market styles: growth stocks (those of fastest-growing companies that trade for higher valuations) and value stocks (fallen out of favor that trade for lower valuations).
While value stocks have outperformed growth on average over the past century, they have experienced significant periods of dominated growth. The past decade has been one such period.
In the fall of 2020, the tide began to turn in favor of value, sparking widespread joy among value managers that maybe – just maybe – their long suffering ended. Most other managers looked on with bewildered attachment, as the growth versus value debate was little more than an intramural rivalry.
Some observers find that attitude shortsighted. They believe that the fortune of growth stocks over value stocks can tell us if we are in a healthy bull market.
On the surface, their argument makes sense. Growth stocks are likely to grow fastest when the economy is in full swing. And economic growth is certainly conducive to a bull market on Wall Street. So it’s obvious that a shift from leadership to value growth could mean an imminent downturn in the market.
This theoretical argument is consistent with the stock market’s experience leading up to and after the bursting of the Internet bubble in 2000. The bull market years of the 1990s were one of the longest periods of the last century in which growth stocks outperformed value. After that bubble burst, value stocks entered one of the longest beating growth periods of the past century.
There are exceptions in the historical record. For example, during the Great Financial Crisis, growth stocks outperformed value on balance. Still, the economy shrank significantly and the stock market collapsed.
What the data tells us
To better understand this confusing relationship between the health of the market and the relative returns of growth and value stocks, I analyzed stock market trends up to mid-1926, courtesy of data from Dartmouth Professor Ken French and Yale University professor Robert Shiller. For each month, I obtained data on the value’s performance relative to growth, as well as the SPX of the S&P 500,
inflation and dividend adjusted performance.
I looked for correlations between the two and came up empty. There were periods when the relative strength of value was associated with lower stock market returns, and others when it was associated with higher returns. There was no set pattern.
This is illustrated in the chart above. It divides the data into two groups of equal size – the first covers the period 1926-1973 and the second the period from 1974 to the present. In the first half of the sample, the stock market outperformed as growth outpaced value. In the second half of the sample, it was just the opposite.
My guess as to why there is an inconsistent correlation between the market and the relative strength of value over growth: there is more than one reason why growth can slip behind value. The strength of the economy is only one reason. Another, which has become particularly relevant in recent decades, is a bubble in growth stock valuations. If such a bubble deflates, growth stocks could seriously lag value stocks, even if the economy as a whole continues to grow.
We saw some of this during the deflation of the Internet bubble between March 2000 and October 2002. Although that bear market lasted two and a half years, the accompanying recession lasted only eight months (March to November 2001, according to the National Bureau of Economic Research, the semi-official arbiter of when recessions begin and end). At the end of that bear market, the US gross domestic product (GDP) was 10% higher than it was at the beginning. Still, the S&P 500 was 49.1% lower. Much of that difference can be attributed to the valuations of growth stocks coming back to Earth.
Value stocks performed relatively well during that bear market. Plus, according to French’s data, average small-cap value stocks actually made money during that bear market.
It comes down to? Relaxed. While much depends on whether the value style has embarked on a multi-year period of better-performing growth, the fate of the bull market is not one of them.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings keeps investment newsletters that pay a fixed fee to be audited. He can be reached at email@example.com
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