Value stocks started to outperform their high-flying growth counterparts earlier this month when Pfizer Pfizer revealed positive results on its COVID-19 vaccine. Savita Subramanian, U.S. quantitative analyst at Bank of America, believes this rotation away from tech and into stocks trading at a much cheaper price relative to earnings has only just begun, in what would be a massive change from recent market trends.
Ms. Subramanian – in my opinion one of the best strategists working on Wall Street – believes we are entering a period when value stocks will outperform growth equities to a similar extent as between early 2000 and late 2001. The growth companies she deems most at risk of underperformance consist of some of the most widely held tech stocks in the world.
Ms. Subramanian first turned bullish on value stocks in July, a bit early, but with a compelling argument. Most importantly, the strategist said in a research report that value stocks had a perfect record in outperforming growth indexes (which are now dominated by technology stocks) in the aftermath of each of the past 14 U.S. recessions. She expects the recovery from the 2020 recession – already well under way – will be no different.
Similarly, value stocks have historically outperformed growth after S&P 500 earnings troughed. The bottoming of U.S. corporate profits occurred in the first quarter this year and the outlook continues to improve. A record 70 per cent of companies have reported earnings and sales above estimates so far in the third quarter.
The outperformance of growth stocks relative to value has been a major theme of 2020, but the trend had clearly reached extremes by early October. At that point the Russell 1000 Growth Index had outperformed the Russell 1000 Value Index by 36 percentage points year to date, which B of A noted was the highest annual spread in the history of their extensive data.
The first accompanying chart shows the relative performance of growth stocks versus value stocks over the long term. The value is calculated simply by dividing the Russell 1000 Growth Index level by the Russell 1000 Value Index, so a rising line indicates that growth stocks are outperforming.
The chart makes clear that the growth index has climbed to unprecedented territory relative to value stocks. The peak in August, 2020, was well above the maximum dislocation seen just before the technology bubble popped in 2000, and value stocks began to outpace growth for a significant period.
The second chart is a recreation of the main exhibit in Ms. Subramanian’s report. The purple line represents the relative performance of growth and value stocks since January of 2019 (a rising line indicates growth stock outperformance).
The data show the difference in value of a US$100 investment in each of the Russell 1000 Growth and Russell 1000 Value indexes in January of 2019. For example, the peak of the purple line shows that on Aug. 31, the original investment in the growth index was worth US$57 more than the same US$100 invested in the value index.
Ms. Subramanian compares recent patterns with the relative returns on growth and value from October, 1989 to September, 2001 (the blue line) – the lead-up and the aftermath of the tech bubble implosion. (Note that the earlier data are “pulled forward” to start at January, 2019, to better show the comparison.) The not-so-subtle implication here is that the recent trend of growth stock outperformance versus value stocks is ending, and value stocks will begin to outperform in a similar fashion as 2000 and 2001.
B of A also provided a list of large cap U.S. growth stocks most at risk of steep declines if market leadership changes from growth to value. The universe consists of Russell 1000 Growth stocks that are also in the S&P 500. Ms. Subramanian then identified those that are most overweight (relative to the benchmark) in active mutual fund and hedge fund portfolios.
The resulting stocks are listed in the accompanying table, ranked by the extent they are overweighted in fund portfolios, along with total returns over three years, one year, three months and one month. Technology stocks dominate, as we would expect. Netflix Inc., Salesforce.com Inc., Facebook Inc., Amazon.com Inc. and Adobe Inc. are counted among stocks with the most to lose if portfolio managers sell their growth companies in favour of value stocks.
Note that some of the companies in the table have underperformed the benchmark significantly over the past month in a potential sign they are already moving out of favour. Netflix, for example, has lagged the benchmark by more than 13 percentage points and Adobe has underperformed by more than 10 percentage points.
If we have reached an inflection point similar to early 2000, investors can expect big changes in market leadership – between March, 2000, and September, 2001, value stocks outperformed growth stocks by well over 30 percentage points.