Tune in to our latest “Talking Markets” podcast and hear more from Stephen Dover and Norm Boersma on the subject.
Growth investing has outpaced value investing for quite some time now, for a number of reasons. One of the main ones relates to the discounted value of money. In economic terms, the lower an interest rate is, the greater the value of future earnings.
Since the global financial crisis of 2008-2009, monetary policy in many economies around the globe has artificially pushed down interest rates.
So in general terms, at times of artificially low interest rates, growth companies—which have more future earnings than they have current earnings— tend to be more attractive to investors than value companies. While we believe both growth and value have a place in an investor’s portfolio and can complement each other, we see reasons to think it may be time for value to shine.
Recent Market Volatility
The recent bout of equity volatility in early February of this year threw the spotlight again on the growth versus value debate.
Volatility in the markets is normal, and we look at it as an opportunity. Value investors are looking for mispriced stocks and when there’s not a lot of volatility, you don’t get a whole lot of mispricing. But as investors pull their money out of the market, they tend to pull it out somewhat indiscriminately. That indiscriminate selling often creates mispricing of stocks based on their fundamentals. Value investors look for opportunities to step in and take advantage of that mispricing.
We think the most recent bout of market volatility represents a return to more normal circumstances. Last year we saw a very steady progression upwards in equity markets around the world. That was unusual. Now people are getting a bit more nervous. We would anticipate pullbacks ahead, and consider them a healthy occurrence—and a source of opportunity to unlock value.
Could the Tide be Turning for Value Investing?
Historically, value investing had outperformed growth over long periods of time, and in periods of great disruption, growth tends to outperform value. When you look at disruption, it can be very hard to pick who the winners are going to be. It might even be easier to pick out who the losers may be.
Value managers are usually looking for a reversion to a mean; trying to identify assets that they consider undervalued at this point but that they think are going to come back. Value managers are also often called contrarian managers because they’re looking at what everybody else is buying or selling, and they typically do the opposite.
Over the last 10 years, we’ve seen one of the longest periods of growth outperformance—possibly the longest ever.
And, growth has largely been concentrated in just a few stocks—namely technology. Technology companies are traditionally seen as growth companies, while financial companies and commodity companies are regarded as value.
Change Can Happen Very Quickly
Value can underperform for a very long period of time and then very rapidly catch up. In our experience, the greater the dispersion between growth and the value, the greater the likelihood that that change will happen fairly quickly. From a value investor’s point of view, we think there shouldn’t be any sector that you cannot invest in at different times.
Value investors aren’t against companies that have growth. What they are against is paying too much for companies and the kind of wild enthusiasm that sometimes happens in the market.
The Impact of Rising Interest Rates
There are a number of factors we think could spell the end of growth investing’s dominance and lead to a resurgence in value investing.
Interest rates are likely to play a central role. We think it’s fair to say this situation of artificially low interest rates won’t continue forever. We’re already seeing signs of rising interest rates and higher inflation, notably in the United States, but also elsewhere.
Rising interest rates are traditionally a sign of a growing economy, and certain sectors traditionally associated with value—notably the financial sector—tend to be very interest-rate sensitive. Rising rates can be helpful to those stocks. Similarly, there are a lot of value stocks in cyclical industries. Economic growth helps those industries to perform better, providing another tailwind.
Health care stocks have in general been under pressure because of worries about pricing concerns in the United States, and there are quite a few companies that have been facing at least short-term issues. That’s created quite a few opportunities for value seekers, particularly in the specialty pharma and biotech space. In the energy sector, oil prices have been low, but are starting to recover. We think there’s still some value to be found in energy, especially in the integrated stocks.
On the other hand, there are some areas that we think have become expensive, in particular the technology sector (which has been very buoyant) and materials.
From a geographical perspective, European equities have lagged behind the United States. Our analysis of the earning spreads between the United Stats and Europe suggests to us that earnings in Europe actually have quite a bit of room to move up.
We think the current economic environment suggests a more favorable outlook for value investing ahead, but reiterate that both growth and value have a place in an investor’s portfolio.
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What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investing in a single-sector involves special risks, including greater sensitivity to economic, political or regulatory developments impacting the sector. Value securities may not increase in price as anticipated or may decline further in value. Growth stock prices reflect projections of future earnings or revenues, and can, therefore, fall dramatically if the company fails to meet those projections.
Diversification does not guarantee profit nor protect against risk of loss.