The Competition Between Growth and Value Stocks

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We haven’t discussed the performance of growth stocks versus value stocks for a while. That’s because with the central banks expanding monetary policy and increasing market liquidity since early 2009, growth stocks have dominated. When investors see the central banks appearing to support the markets, they perceive little risk and buy the higher risk, higher reward investments. They buy growth stocks instead of value stocks.

It’s no secret that value stocks in general, and actively-managed value stock funds in particular, have lagged the bull market since the bottom of the financial crisis. The evidence is in the returns of the great long-term value funds, such as Dodge & Cox Stock, Oakmark, Mutual Shares, and others. But some analysts say that with the Fed reducing its stimulus and growth stocks becoming overextended, it is time for value stocks to surge ahead. Let’s take a look at some data.

Over the long-term value stocks are big winners. Consider the iShares Russell 1000 ETFs. Since their inception in May 2000, the value ETF (ticker: IWD) has handily beaten both the growth ETF (IWB) and the blended Russell 1000 ETF (IWF). Value has a compounded return as of the end of March of 148.74%. The blended ETF returned 104.06%, and the growth ETF returned 45.79%.

But over the last five years, growth returned 77.50% while value returned 61.30%, and the blended ETF returned 70.09%. The story is similar for the last three years. Even over the most recent 12 months, growth returned 2.32% while value lost 1.67%, and the blended index returned 0.48%.

So, why should an investor consider tilting a stock portfolio toward value stocks?

One reason is history. Since academics began researching stock returns in detail, there’s been a consistent long-term advantage to value stocks. There are periods when value stocks lag, but over the long-term, value stocks deliver a higher total return. They also have less volatility, so they deliver higher returns with lower risk.

The last 10 years or so have been the longest period when value lagged growth. So, you can simply argue that value stocks are due to outperform. Some analysts argue, however, that markets have become more efficient and respond faster to change. They believe there’s no reason to expect the value stock advantage to return.

Another reason to consider value stocks is recent performance. Only a few growth stocks were doing well in 2015 and pushing the indexes higher before the August decline. Those stocks suffered the most in the decline and continued to struggle into 2016.

In 2016, value stocks began to move ahead of growth stocks in late January through February and shot ahead of growth stocks through most of March. Growth stocks staged a recovery in early April. The three ETFs now essentially are tied year to date.

Now, let’s look at smaller stocks, using the iShares Russell 2000 ETFs. Academics have found that smaller companies’ stocks tend to outperform larger-company stocks, and value stocks beat growth stocks over the long term. The iShares Russell 2000 Value (IWN) is well ahead of both the growth version (IWO) and blended index (IWM) since their inception in 2000. Value returned 264.78% versus 91.63% for growth and 171.24% for the blend.

But over 10 years, five years, and three years, growth is well ahead of value. Over the last year, however, value is back in the lead, though each ETF has negative returns for the last 12 months. Small-cap value has surged since mid-December 2015 and is well ahead of the others for six months and three months. As with the larger-company stocks, however, growth surged ahead in the last month, returning 2.49% versus 1.41% for value and 1.92% for the blended index.

One reason value has lagged is that banks and other financial stocks tend to be heavily-weighted in value indexes and funds. Those stocks have been poor performers because of the financial crisis and its aftermath, especially tighter regulations. It’s not clear whether financial companies will do better in the future or value indexes and funds will move away from the sector.

Also, after the Fed raised interest rates last December and forecast it would raise rates four times in 2016, value began to outperform growth. Once it was clear the Fed wouldn’t raise rates as much in 2016 as originally thought, investors sought risk again and returned to growth stocks. It appears that as long as monetary policy is very expansive, it is likely that growth stocks will do better than value stocks.

The Data

There wasn’t much economic data in the last week. Most of what was issued wasn’t greeted warmly by investors. But investors were excited by reports that oil output is declining, despite the failure of OPEC members to agree on a change in output, and hope that a meeting this weekend will result in an agreement to further reduce output.

The NFIB Small Business Optimism Index declined again. The decline wasn’t much, but analysts expected a rise to counter last month’s sizeable decline. The index now is at a two-year low and is well below the historic average. The index lagged through the early stages of the economic recovery because the initial stages of recovery helped big businesses. But steady improvement in the last two years indicated growth was spreading through the economy. The recent numbers are increasing concerns about broad-based slower growth.

Retail sales declined by 0.3%. Household demand has been the major support for the economy, so weakness here is a concern. Last month’s report was revised slightly higher to indicate no change in sales. This number is volatile, so it’s important not to read too much into one report.

Auto sales are volatile, and gasoline sales depend more on the price at the pump than on demand or income changes. When autos are excluded, sales rose 0.2% in the last month, still a weak number. Excluding only gasoline, however, sales declined 0.4%. Excluding both autos and gasoline shows a 0.1% increase. Over 12 months all of the measures are below 4%, and the 12-month measures show sizeable declines from last month.

Real retail sales are an important early indicator of recession, so I watch these numbers closely. But they are volatile, so we need to see a trend for several months before reaching a conclusion.

Wholesale prices as measured by the Producer Price Index declined for another month. The 12-month change also is a negative 0.1%. After excluding food and energy, the 12-month change is only a 1% increase. The low numbers are surprising, because energy prices increased almost 2% during the month.

Consumer prices also increased a modest 0.1% and are up less than 1% over 12 months. After excluding food and energy, the monthly change is the same and the 12-month change is 2.2%. One interesting factor here is housing. A large part of the CPI is owners’-equivalent rent as the housing component. Since rents have been rising rapidly after the financial crisis, the housing component exaggerated the increase in the CPI. More recently, there have been indications that rents are peaking. This month, this factor declined and helped hold down the CPI.

New unemployment claims dropped by 13,000 to 253,000. This ties the March 5report for the lowest number of claims since 1973. Remember, the workforce was much smaller in 1973, since adjusted for the size of the workforce we’re well into record low territory. This again shows the mixed health of the labor market. Though few people are losing their jobs involuntarily, wage growth remains very modest.

On Friday we’ll have the first of the month’s reports on manufacturing. We’ll see if last month’s improvements continue or were anomalies.

The Markets

Earnings season began, and earnings generally weren’t positive. But investors appeared were satisfied by anything that beat lowered expectations to push stocks higher in the last week.

The Dow Jones Industrial Average rose 1.06% in the last week, as of around middayThursday. The S&P 500 returned 0.77%. The Russell 2000 is up 1.94%. The All-Country World Index returned 2.21%, and emerging market equities led the way with a 4.36% return.

Long-term treasuries gained only 0.12%. Investment-grade bonds lost 0.02%. Treasury Inflation-Protected Securities (TIPS) lost 0.44%. High-yield bonds gained 1.35%.

The dollar gained about 0.8%.

Energy-based commodities had a strong week, gaining 6.2%. Broader-based commodities gained 5.20%, and gold gained 1.61%.

Some Reading for You
This article explains why people with healthy lifestyles still might not be healthy.
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There’s an industry devoted to supplying people for protests, demonstrations, and other media events.
I comment and link to these and other items on my public blog at http://www.bobcarlson.net.

Sincerely,