May 13, 2021 | Vanguard Perspective
Our outlook for value? Brighter days ahead!
Over the last 10 years, U.S. growth stocks outperformed U.S. value stocks by an average of 7.8% per year.1 Powered by a relentless rise in technology share prices, growth stocks have handily outpaced value since the 2008 global financial crisis. Simply put, growth has historically never outperformed value as it has over this past decade.
Are we seeing a reversal of fortune with the value premium asserting itself once again? Will your clients' asset allocation strategies be positioned to take advantage of this shift?
Vanguard's latest research suggests that there is a fundamental explanation for some of value stocks' recent woes, such as the inflation and growth environment, but that the narrative has been oversold. Based on our fair-value model, we expect value to outperform growth over the next 10-year period by as much as 5% to 7% per year and perhaps by even more over the next five years.
The unprecedented recent outperformance of growth over value
Secular trends are driving fair values, but the market may have overreacted
Our model suggests that value stocks’ underperformance in recent years owes mainly to fundamental drivers, notably, low inflation rates, which boosted the relative attractiveness of growth stocks' more distant cash flows. But investor behavior played a role as well.
The model highlights some key points about our fair-value estimates:
- The decline in the fair value of value/growth has more to do with a large increase in the fair value of growth/market than with a large decrease in that of value/market.
- Value stocks are much more sensitive to cyclical drivers such as market volatility and corporate profits than are growth stocks.
- Growth and value appear to be at the upper and lower bounds of their respective fair value to market estimates.
Value stock price/book ratio divided by growth stock price/book ratio
Value signaling a resurgence
We believe that cyclical value-growth rotations are rooted in investor behavior and that investors become more price-conscious when profit growth is strong. Since 2008, corporate profit growth has been insufficient to sustain value stocks.
As inflation normalizes, we expect it to eventually exceed the Federal Reserve's target. Improved performance from the energy, materials, and financial sectors may be signaling a resurgence in these beaten-down value-oriented segments. However, the ultimate driver of the predicted rotation to value stocks is apt to be a change in investors' appetite for risk.
Our research found that deviations from fair value and future relative returns share an inverse and statistically significant relationship over the next 5- and 10-year periods. The relationship is an affirmation that, ultimately, valuations matter—that the price we pay influences our return.
The drivers of value outperformance over the next 5- and 10-year periods
Eventually, we believe that value will take the lead again, as it did through most of the first decade of this millennium. For investors with sufficient risk tolerance, time horizons, and patience, an overweight to value stocks could help offset the lower broad-market returns we expect over the next decade.
View our lineup of low-cost value Vanguard ETFs®
|Mega Cap Value||MGV||0.07%|
|Russell 1000 Value||VONV||0.08%|
|Russell 2000 Value||VTWV||0.15%|
|S&P 500 Value||VOOV||0.10%|
|S&P Mid-Cap 400 Value||IVOV||0.15%|
|S&P Small-Cap 600 Value||VIOV||0.15%|
|U.S. Value Factor||VFVA||0.14%|
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