Hopefully, you have a 401k or a similar retirement plan. Or, maybe you manage your own IRA. Typically, when you look at how to invest that money, you look Morningstar or a similar service and you decide among various mutual funds. Morningstar classifies equity (i.e., stock) funds as either Value or Growth (or a blend of the two). They also use Small Cap and Large Cap, but that’s not part of my point.
If you have tried to diversify your equity funds, perhaps you have put some of your money into Growth funds and some of your money into Value funds. Over the past year, if you have allocated thus, you have probably noticed that your Growth funds have gone up more than have your Value funds.
According to a recent Wall Street Journal article, growth stocks have outperformed value stocks by 19% this year alone. Here is the link to the article:
I believe there are several reasons why growth stocks have outperformed. Some are mentioned in the WSJ article, and some are not. Here are my thoughts:
- It is difficult to find “value” when the indexes are trading at all-time highs, as they are as I write this blog. “Value” implies that an asset is undervalued, and undervalued assets are harder to find if everything is up.
- The markets haven’t had a major correction for almost 10 years. It is during and coming out the other side of corrections when one finds the best value investing opportunities.
- Interest rates are low, so TINA – there is no alternative to investing in stocks.
- The Tech sector has been particularly on fire and tech is not a sector one looks at to find value, typically.
- Value stocks are usually found in more mature industries or sectors. New technologies and new entrants to the marketplace are forcing out more mature players. The best example is Amazon and online retailing wreaking havoc on the traditional retail sector.
- Index investing is particularly harmful to value investors. Value investing is rooted in the superior analysis of individual businesses and learning something about an individual business that the rest of the market is unaware of. Index investing is the antithesis of that type of thorough analysis. As more and more money flows toward index investing and away from the traditional search for undervalued assets, the values of the assets which make up the indexes get inflated to the detriment of the value assets.
If Growth has outperformed and Value has been left in the dust, does that mean Value is dead? Or does it mean that there are opportunities to find undervalued opportunities? I don’t know, but it is something to keep your eye on. If you believe in Mean Reversion – that Growth and Value stocks will trade within a certain range of one another, and that the past year has been an anomaly and that the historic range will return – then possibly Growth and Value stocks will start again to trade in tandem. But does that mean that the 19% of over-performance by Growth over the past year will be rectified? Again, I don’t know, but I would look to the future rather than the past.
If Growth and Value stocks are to return to historical proportions, then I would say there will need to be a catalyst to make that happen. In other words, one or several of the reasons why Growth has outperformed over the past year will need to change. Do you believe any of the bullet-point reasons I outline above will change in the near future? They very well may, particularly if something on the outside changes – perhaps a geopolitical catastrophe, or another disruptive tech phase, or an investing bubble exposed. The stock market has always corrected in the past. Could this time be different? Unlikely, but we will see what form any correction takes, and how deep it is.
I am not recommending that you reallocate some of your Growth funds over to Value funds because Value is undervalued. I am simply pointing out a phenomenon in the stock market over the past year and providing my take on why this has occurred. Remain vigilant.