For the past decade, the competition between growth and
value stocks has been decidedly short on suspense — growth has consistently
come out on top. But value stocks recently disrupted this storyline with a
rousing rally. Was this simply a blip? Or was it a preview of a lasting
Below, Brian Levitt, Invesco’s Global Market Strategist
for North America, and Talley Léger,
an Invesco Investment Strategist who specializes in the equity markets, discuss
whether the conditions are right for a longer-term shift to value.
Brian: The last
wrote a blog together, I asked you if the inverted yield curve was keeping
you up at night. That was back in September, and neither of us seemed to be losing
sleep. We reasoned that the inverted yield curve was reflective of multiple
policy mistakes — the 2018 Federal Reserve (Fed) rate hikes and the ongoing
uncertainty of the trade war — and that the curve would steepen modestly amid a
better policy mix. Fast forward to today: The Fed has been easing policy and
there are hints of incremental progress on trade. The yield curve is no longer
inverted, and US stocks have been hitting all-time highs.1
A funny thing happened on the way to those all-time highs.
The markets, which had been led by growth stocks for the past decade, were
briefly led by value stocks.2 Was that just a short-lived rally or a
hint of a longer-term shift to come?
Talley: In my
view, there are a few signposts that can help us determine whether we’re on a
new road toward value outperformance — or if we simply took a short detour. You
mentioned two: Fed interest rate cuts and a steepening yield curve. I believe a
durable value regime depends on the outlook for both.
The yield curve (or difference between short- and
long-term interest rates) is a transmission mechanism for monetary policy. The
Fed manipulates the slope of the curve by either raising short-term rates to
flatten the curve (2018) or lowering them to steepen it (2019). True, Fed Chair
Jerome Powell has signaled no more cuts this year. However, the Fed’s own
Underlying Inflation Gauge suggests core consumer price inflation should cool
in 2020, giving Powell scope to reduce rates further next year.
Why is this important to your question? In a nutshell, the
yield curve provides signals from the bond market on whether the economic
outlook is getting better or worse. As such, it’s no coincidence that the curve
is positively correlated to the performance of value stocks relative to growth
Another signpost I’m watching for is a shift in sector
leadership to financials (the value heavyweight) from technology (the growth
heavyweight), but that ratio hasn’t turned convincingly yet.
To answer your question, I think it’s possible that 2020
could be the year of a temporary or “mini” rotation to value. But I’m
unsure it’ll last.
always been taught that value-oriented assets require a catalyst to sustain
outperformance, namely a new higher level of growth in the economy. Is that possible? It seems as if we are at or near full
employment, and it’s unlikely to me that a surge in productivity gains is
coming our way.
You mention the Fed interest rate cuts and the steepening
yield curve. Wasn’t the Fed simply unwinding
the policy mistakes of 2018 — or at least what the bond market viewed to be
policy mistakes? The yield curve had
inverted in August, financial conditions were tight, and inflation expectations
were falling. They had to respond. The Fed succeeded in normalizing the yield
curve, although truth be told the spread between long rates and short rates has
remained very tight and has narrowed in recent weeks.
Nonetheless, long rates (as defined by the 10-year US
Treasury rate) have climbed from a very depressed and overbought condition
(1.45% on Labor Day) towards 2.00% (1.95% on Nov. 8), a level that is more
reflective of trend real gross domestic product.3 It’s no surprise then that value stocks would
have led the market as the economy recovered and rates backed up towards 2.00%.
But is that all there is to this story? Sure, the Fed could lower rates
again. We could get a US-China trade
deal. A better policy mix could further
steepen the yield curve and support value in the near term. But aren’t we ultimately destined to return
to a slow growth world with the Fed not doing much of anything for the
It seems as if that is what the financials/technology
ratio is telling you. So, is the idea to
own value-oriented cyclicals now and then transition to growth-oriented
cyclicals? Or do we continue to favor the true growth assets in what continues
to be a slow-growth world?
population growth of less than 1% and productivity growth of less than 2%,4
I think it’s unlikely the US economy can sustain a faster pace of activity. In
other words, the structural growth outlook remains modest and hasn’t changed,
in my view.
That said, I’m simply talking about the cyclical growth
outlook, which has received a near-term boost from easing monetary, financial
and credit conditions, as well as curve steepening, diminishing recession risk,
trade progress, a softer US dollar and improving global growth.
In terms of sector strategy, it’s possible that cyclical
leadership could ebb and flow between growth cyclicals such as technology and consumer
discretionary, and value cyclicals such as financials, energy, real estate and materials.
Industrials could be seen as a “core” cyclical sector, balanced between growth
However, the flow back to growth cyclicals may await a
higher federal funds rate, flattening yield curve, and tighter monetary policy.
How could that sequence of events unfold? If the growth
outlook has indeed improved as described above, would that eventually bring the
Fed back into the game? If so, would we return to the higher funds rate/flatter
curve/tighter policy regime of 2018? Such sequencing would take time, perhaps
beyond our 2020 forecast horizon.
I don’t mean to over-finesse the nuances. The bottom line
is I think we could be facing a value rally of playable magnitude, but
ultimately insufficient duration.
value rally of playable magnitude, but ultimately insufficient duration.” I like that.
You are a wordsmith.
I’d like to dig more into the playable magnitude concept,
particularly given how focused we are on Fed policy and the shape of the yield
curve. Since the Fed lowered rates on
July 31, 2019, large-cap value stocks have outperformed large-cap growth stocks
(as shown in Figure 1) by 2.6% on a price-return basis (as of Nov. 26,
2019). However, consider the Alan
Greenspan mid-cycle rate cut in the mid-1990s.
Value stocks and growth stocks were essentially neck-and-neck for most
of the next three years, only for growth stocks to outperform value stocks
massively over the final 18 months of the bull market.
What’s the lesson?
Scenario A: Continue to favor growth because it may keep up with value during
a Fed easing cycle and outperform in the later stages of the cycle? Or Scenario
B: Start building value into your portfolio because the late 1990s ended badly
for growth stocks?
S&P 500 Value Index and S&P 500 Growth Index: Growth of $100 (1995-2019)
Personally, I’m in camp A for two primary reasons: 1) As the
saying goes, we make hay when the sun shines, and the valuations of US-growth-oriented
equities do not currently appear to be anywhere near as excessive as they were
in the late 1990s, and 2) I believe that the markets will continue to favor
growth in what will continue to be a slow-growth world, as they have since the
global financial crisis.
Talley: In my
opinion, the more cyclical Scenario A
runs the risk of missing a potential, albeit tactical, value rotation. Meanwhile, the more secular Scenario B could require much patience on the part of value
investors. Alternatively, there’s another option worth considering — Scenario C:
Embrace an agnostic approach to style investing for the remainder of the cycle
or until the cross-currents buffeting value and growth stocks sort themselves
In the June 2019 update of my Equity Strategy Playbook, I curbed my enthusiasm for growth and technology stocks — which served me well for the better part of three years — by adopting a blend of growth and value. At that time, valuations were one of my key reasons for downgrading growth. Specifically, the price-to-book ratio of large-cap growth relative to value had eclipsed the peak that it set in the heady days of the technology growth stock bubble of 2000.
We could debate our choice of valuation metrics, but suffice
it to say your performance calculations and style benchmarks seem to support my
recent change of view, at least for now. Stay tuned.
1 As of Nov. 13, the S&P 500 has hit 20 record
closing highs during 2019. Source: The Financial Times, “S&P 500’s latest
record high takes it past 2018’s tally,” Nov. 13, 2019
2 As measured by the S&P 500 Value Index and the
S&P 500 Growth Index.
3 Source: Bloomberg, L.P.
4 Source: US Bureau of Labor Statistics
Blog header image: photo-nic.co.uk
The price-to-book (P/B) ratiois calculated by dividing the market
price of a stock by the book value per share.
The S&P 500® Growth Index consists of stocks in the
S&P 500® Index that exhibit strong growth characteristics based on three
growth and four value factors.
The S&P 500® Value Index consists of
stocks in the S&P 500® Index
that exhibit strong value characteristics based on three measures: book
value-to-price, earnings-to-price and sales-to-price.
The S&P 500®
Index is an unmanaged index considered representative of the US stock market.
The opinions referenced above are those of the
authors as of Dec. 11, 2019. These
comments should not be construed as recommendations, but as an illustration of
broader themes. Forward-looking statements are not guarantees of future
results. They involve risks, uncertainties and assumptions; there can be no
assurance that actual results will not differ materially from expectations.