This week's chart is so potentially important for portfolio strategy that I don't feel bad at all for blatantly borrowing the idea from All-Star Charts' J.C. Parets.
It shows that if current trends continue, the future will see value investors outperform growth investors for the first time since the financial crisis.
The chart shows the relative performance of the S&P 500 Value Index and S&P 500 Growth index by dividing each by the base S&P 500 index over time.
Growth stocks have steadily outperformed value since 2010. But this trend reversed sharply in March of this year as weak technology and biotech stocks sent the growth index into a tailspin.
While the high flyers plummeted back to earth, the value index rallied on the back of old economy stocks like utilities Pepco Holdings Inc. (up 32 per cent since the end of February), Exelon Corp. (17.5 per cent) and energy producers like Valero Energy Corp (21 per cent) and Anadarko Petroleum (18.2 per cent).
There have been periods in the past five years where value has outperformed growth, but never has the move been this fast, this big. And there are reasons to believe it may continue.
There are two market environments where value stocks have historically outperformed. When the market is falling, the low prices of value stocks provide downside protection and on average, they fall less than growth stocks. Value stocks also outperform during economic recoveries, when the best investment returns result from buying stocks representing future streams of earnings at the cheapest possible price (in terms of valuations like price earnings, price to cash flow and enterprise value to EBITDA).
Friday's positive report on U.S. employment, combined with rising wages and consumer spending, suggested that the long-awaited sustainable U.S. economic recovery may be underway. As profit growth becomes evident in more industries, value investing should outperform.
The move from growth to value in the S&P 500 should also be visible in Canada, but it will be harder to see. The S&P/TSX Composite is dominated by bank stocks which can almost always be categorized as "growth at a reasonable price" – straddling growth and value. Also, returns in the materials sector which makes up more than a third of the TSX, is often driven by emerging markets demand, rather than domestic or U.S. economic growth.
Investors adding to U.S equity positions should shift their focus from high-multiple, speculative companies to those with low price-earnings and price-to-book ratios, where economic growth will sharply improve profit growth.
Over a full market cycle, holding attractively valued stocks is a proven method of generating strong returns. Now, with an apparent change in trend towards value stocks, it's an even better idea.
Value investors grab the lead
SOURCE: Scott Barlow/Bloomberg