Rotation is a term used in our industry to describe the flow of investor capital as it moves from one investment style, or asset class, to another. There are two main investment styles employed by most mutual fund managers. Growth, or momentum style money managers are interested in getting the best quality companies, regardless of price. “You get what you pay for” they say, and they don’t mind paying up for the best. Stocks favored by this style of money management would include: Tesla, Amazon, Netflix, Nvidia and other technology companies. Value money managers, on the other hand, are looking for bargains. They claim the two styles of money management are value and overvalued. Warren Buffett is the most famous value fund manager. In simplistic terms, both types of money managers evaluate the same price/earnings (P/E) ratio metric. While value fund managers focus on the P, growth fund managers emphasize the E.
Over the past several decades the market has, at times, favored growth and at other times investors have preferred value. However, for the past 15 years the outperformance of growth style investing has been truly astonishing. According to Morningstar, “the Russell 3000 value index has lagged the Russell 3000 Growth Index by a staggering 5.9 percentage points annualized from the end of 2006 through May 2020! It’s the longest stretch of underperformance U.S. Value stocks have ever experienced”. *
This trend to growth has been aided by declining interest rates, which encourage investors to favor higher P/E stocks. Covid 19 further accelerated this trend as the economy was closed and consumers were restricted to using technology to meet their needs and desires. The so called “stay at home stocks” were mostly technology companies that trade at extreme multiples. While cyclical companies that tend to be more value oriented suffered during a closed economy. However, the long-awaited rotation of investor capital from growth-oriented stocks may have begun, and if so, it is a trend that may last quite some time.
Now that vaccines are becoming available, interest rates are on the rise and value stocks have recently (since November) outperformed. Most economists predict strong economic growth next year, aided by a government stimulus program. Has the tide finally turned?
While no one knows which strategy will yield the best results over the next year or two, history suggests that investment results tend to revert to the mean. In other words, the longer growth outperforms value, the more likely it becomes that value will come back in favor. Although it may make sense to overweight value in this market, we believe the best strategy involves a well-diversified portfolio employing both of these strategies.
* Morningstar.com June 2020: Value Isn’t Broken, Alex Bryan