Investing

Another Great Debate

Lots of debates in the financial markets going on today that will probably continue for the foreseeable future. They all seem to come back to one debate in particular, inflation versus disinflation. I’ve written about that a few times and have concluded that nobody can predict with any reliable certainty what is going to happen and that for now excessive inflation probably isn’t in the cards.

A subset of this debate is the Value versus Growth debate. Is Value really that undervalued relative to Growth? From a total return perspective, you can see in the chart below that we are near an extreme low point in the Value relative to Growth dynamic. These extreme low points appear to occur in 20-year intervals, so if history is any indication then Value may go on to outperform Growth for a number of years (7-8 years is the range of Value’s outperformance relative to Growth in the previous two episodes).

Obviously, no two periods in history are the same so whether Value goes on to outperform Growth for any meaningful period of time remains to be seen. Many investment professionals are convinced we’re in a for a long period of outperformance by Value, which may very well be the case. It certainly won’t be a straight line up as the last nearly two months have demonstrated. It never is a straight line up, unfortunately.

From a valuation perspective, total stock market cap relative to US GDP has never been higher. I’m not sure this means anything for the Value versus Growth dynamic but it could mean something for overall stock performance from here. (As the world has become increasingly more global and companies generate more revenues overseas, I’m not sure this is the most meaningful valuation dynamic but it does provide perspective.)

At the 1980 nadir of the Value versus Growth relationship, total stock market cap to GDP was not surprisingly near an all-time low. Value went on to Outperform growth, on a total return basis, for over eight years returning over 320% relative to Growth’s 180%.

At the 2000 trough, Value went on to outperform growth for over seven years returning 109% versus Growth’s return of 24%.

What’s interesting about these two episodes in the Value versus Growth saga is that in the 1980s, both Value and Growth generated positive returns, likely the result of the low valuation level starting point. In the 2000’s, Value’s total return was positive while Growth’s was negative, likely the result of the high valuation level starting point for Growth stocks. The outperformance in both episodes was fairly similar (140% in the 1980s and 133% in the 2000s).

It makes sense that the valuation starting point for both sets of stocks historically determined the ultimate returns. If Value goes on to outperform Growth, it appears it could do so for several years and by a wide a margin. Whether this happens or not is anyone’s best guess. Maintaining a balanced portfolio is always the best approach in these instances as correctly identifying what will happen and when is very hard to do. However, using history as a guide it might make sense to tilt portfolios a little more towards the Value factor.