September 2, 2020 | Vanguard Perspective
East versus West, Seabiscuit versus War Admiral, Kansas City- versus Memphis-style barbecue—history, sports, and culture are filled with long-standing rivalries and reversals of fortune. Such ebbs and flows can also apply to the dynamics of investments and specifically those of growth and value stocks.
The long dominance of growth stocks has continued well into 2020, even when it seemed the pendulum would swing the other way after the pandemic-induced market correction earlier in the year.
It's been a banner period for growth equity funds, such as Vanguard U.S. Growth Fund, which posted the highest absolute return among Vanguard's active equity funds over one-, three-, five- and ten-year periods through July 2020. The growth tailwind, combined with superior stock selection, led to the stellar results.
Meanwhile, value funds, or those straddling growth and value, also rebounded strongly from the market lows in March, but returns were modest when compared with their growth counterparts. Many investors believed that the next downturn would lead to the reversal of growth's bull run, but instead, the unique environment gave extra momentum to the upswing.
Despite the challenges presented by the pandemic, certain key growth companies benefited further from their economies of scale, networking effects, and near infinite access to cheap capital, according to Daniel Pozen, senior managing director at Wellington Management Company and equity portfolio manager for the balanced Vanguard Wellington Fund.
"COVID has been the equivalent of throwing gasoline on the fire" further fueling the disparity between growth and value, Pozen said in a recent webcast.
Our clients often ask when the pendulum will swing the other way. It helps to take stock of the past and examine how the current trend took root.
From the end of the previous global financial crisis until the pandemic, we experienced an economic expansion of near-record duration. This expansion, with support from a low interest rate environment, has greatly benefited growth equities, a trend that outlasted even the short-lived market correction we had in the first quarter.
The second quarter highlighted the further transition to the "new economy," with sizeable increases in growth-oriented technology stocks such as e-commerce platforms. The dispersion between growth and value returns has widened by almost 14 percentage points for the second quarter and 32 percentage points over the 12 months through June 30.
|Russell 1000 Value Index||14.29%||–16.26%||–8.84%||1.82%||4.64%||10.41%|
|Russell 1000 Growth Index||27.84%||9.81%||23.28%||18.99%||15.89%||17.23%|
|Difference in percentage points||–13.55||–26.07||–32.12||–17.17||–11.25||–6.82|
Returns are annualized for periods longer than one year. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Source: Vanguard, using data from Russell, as of June 30, 2020.
The next chart shows the difference in annualized total returns between the Russell 1000 Value Index and the Russell 1000 Growth Index over rolling five-year periods. Value stocks were dominant for a number of years after the dot-com implosion of 2000 until the 2007–2009 global financial crisis. From 2009, an expanding economy has been the tailwind for growth stocks, creating the longest period that growth has outperformed value.
When looking at the characteristics of the Russell 1000 Value and Growth Indexes over the last five years, one thing stands out: Growth has become more expensive over time, leading to strong returns and increased market capitalization of the Russell 1000 Growth Index. Other metrics have followed suit. Price to earnings, price to cash flow, price to book, and price to sales have also increased, while the same metrics for Russell 1000 Value have essentially stayed the same. One can argue that growth’s higher projected earnings-per-share growth can partly justify the higher price.
|June 30, 2015||June 30, 2020|
|Russell 1000 Value||Russell 1000 Growth||Russell 1000 Value||Russell 1000 Growth|
|Number of stocks||684||644||839||435|
|Market capitalization ($ millions)||106,174||129,853||113,586||575,176|
|Est. 3–5-year EPS growth||8.7||14.3||4.6||18.0|
Source: Vanguard, using data from FactSet, as of June 30, 2020.
A few stocks were responsible for almost one-third of the stock market's gain. During the five years through mid-2020, the overall Russell 1000 Index had a cumulative return of 65.5%. But if you eliminate the top five contributors—Microsoft, Amazon, Apple, Facebook, and Alphabet (the parent company of Google)—the index's return would drop to 45.5%, shaving off 20 percentage points. (Source: Vanguard, using data from FactSet, as of June 30, 2020.)
Fund managers who had no exposure or an underweight to these few names lagged growth benchmarks. This was true even for growth-oriented portfolios if they sidestepped these dominant positions.
Inevitably, value will eventually take the lead again, as it did through most of the first decade of this millennium. But Pozen declined to hazard a guess on when, thinking it a fool's errand.
Outside of the timing, he believes stock selection will once again supplant the pandemic-influenced environment as the primary driver of differentiated returns. Value companies will benefit from the eventual return to more normal conditions and a potential shift from monetary to fiscal stimulus that could change the inflation and interest rate environment.
Investors and investment committees will have to decide whether they have enough conviction in the continued dominance of growth or the resurgence of value. If there is no strong conviction, maintaining a balanced exposure to both growth and value in your portfolio can be a great way to deal with the uncertainty.
For the performance of Vanguard funds at the most recent quarter-end, go to related links or to www.vanguard.com/performance.