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Value is Trumping Growth

An individual stock can be described in many ways and can be categorized using many different metrics.  At a simple level, for example, stocks can be domestic or foreign.  With respect to the market's valuation of a company's total stock outstanding, i.e. a company's "market capitalization", there are mega-cap stocks on down to micro-cap stocks.

Some stocks are deemed to be "value" stocks, while others are labeled "growth" stocks.  The "value" label is most commonly given to stocks with low prices relative to the company's earnings or sales revenue or cash flow or accounting book value. "Growth" stocks are usually called that by virtue of having relatively rapid or consistent growth in earnings and/or sales.

It's not necessarily the case that the value stock and growth stock categories be mutually exclusive.  A given stock may exhibit some value characteristics and some growth characteristics, and in fact there is a subset of active mutual fund managers who seek to find stocks exhibiting growth-at-a-reasonable-price or GARP.  But as is often the case in investing, compromises must usually be made.  It's rare to find a cheap stock with unquestioned prospects for growth.

For this reason, mutual fund investors are consigned to choose among funds focusing on value stocks, funds focusing on growth stocks, or funds that combine the two traits, usually without effectively attaining exposure to either (so-called "blend" funds).  The $64,000 question then becomes: historically speaking, which have generated better returns, value stocks or growth stocks?

The unequivocal answer to that question is that, over very long time periods, ones measured in decades, value stocks have outperformed growth stocks.  And this result is very robust.  In other words, U.S. value stocks have outperformed U.S. growth stocks, foreign value stocks have outperformed foreign growth stocks, large-cap value stocks have outperformed large-cap growth stocks, small-cap value stocks have outperformed small-cap growth stocks, and so on.

The difficulty for investors is that there have also been many multi-year periods during which growth stocks have outperformed value stocks.  Again, as is often the case in investing, returns revert to the mean.  We seem to experience alternating multi-year cycles in which investors reward value stocks and then reward growth stocks and then reward value stocks again, etc.

As a fairly recent illustration of this flip-flop behavior, you may remember that growth stocks were all the rage during the tech bubble of the mid-to-late '90s. When that bubble burst in the early 2000's, value stocks came back into vogue for a number of years.  That multi-year love affair with value stocks, led by housing-related stocks and financials, ended with the real estate bust, and growth stocks have again been leading the charge almost ever since (think Facebook, Amazon, Netflix and Google).

That is, until recently.  The middle of last year seems (with heavy emphasis) to have marked another shift from growth stocks back to value stocks, both here and abroad.  During the last 6 months, the S&P 500 Value Index has returned 7%, about double the return of its Growth counterpart.  The shift in foreign stocks has been even more pronounced, with Value beating Growth by about 12 percentage points during the same time.

Whether last year really marked the beginning of another multi-year period in which Value stocks and funds will outperform their Growth brethren, we'll only know in hindsight.  (We certainly hope so because that's the way we've been positioning portfolios.)  And why this transition in market leadership has taken place - the leading candidates being rising interest rates, Trump's election, better global growth prospects, and renascent inflation - is somewhat irrelevant.  (We suspect that interest rates are the leading culprit, but that's fodder for another story.)

What is clear is that the last few years have been difficult and frustrating ones for value-oriented mutual fund managers and for investment advisors expecting the Value style to re-assert itself.  But this has merely been another in a long line of episodes in which financial markets severely test one's patience and expectations. And it's during trying  times like these when only a consistent and disciplined investment process will see you through to the other side successfully.

"The race is not always to the swift, nor the battle to the strong, but that's the way to bet."

- Damon Runyon