U.S. growth stocks are enjoying their longest period of outperformance on record, having beaten their value counterparts for much of the past 12 years. Is that about to change? No, we think the twilight of the growth style of investing is being exaggerated.
The sector composition of the growth and value indices offers an important clue, which can be overlooked as a driver of the style cycle and lead to unintended sector positioning. Specifically, technology is the biggest sector of the Russell 1000 Growth Index. That means it’s difficult to love growth and hate tech. Meanwhile, financials are the largest segment of the Russell 1000 Value Index, so it’s inconsistent to hate value and love financials (Exhibit 1).
Given their polarized market-capitalization weights, the performance of tech relative to financials is a good directional indicator for the style cycle. Pro-growth-oriented index strategies, which emphasize stocks with higher forecasted earnings growth rates, are an implicit call on continued tech leadership. A passive value style of investing, favoring stocks with lower price-to-book ratios, is essentially a play on financial outperformance, which explains why it isn’t working (Exhibit 2).
After a temporary selloff, the S&P 500 Information Technology sector has rebounded and remains in an uptrend, supported by strong sales and earnings growth. Also, recent news of Apple Inc. (AAPL) becoming the first U.S. company to achieve a $1 trillion market capitalization—fueled by second-quarter earnings results that topped expectations—helped to restore investor confidence.
Investor concerns about rich valuations, high concentration, and narrow participation in the tech sector are valid. However, a cycle-on-cycle analysis shows that tech stocks ballooned 1,509% from their low in October 1990. Over the same 10-year holding period, tech stocks have risen just 478% from their low in February 2009, a comparative shortfall of 1,031%. If past is prologue, tech stocks may have some room to run, especially if investors stay willing to pay up for strong sales and earnings growth (Exhibit 3).
What else can we look at for clues about the style cycle? The U.S. Treasury yield curve is a leading economic indicator, a transmission mechanism for monetary policy, and a real-time market proxy for bank net interest margins (NIMs). When the Federal Reserve (Fed) tightens monetary policy, raises interest rates, and flattens the curve—thereby discouraging risk taking and lending, which is exactly what it’s doing—high-quality, stable tech companies tend to benefit at the expense of undervalued financial companies. In our view, we remain firmly in a technology and growth regime as long as the yield curve keeps flattening (Exhibit 4).
A keen focus on government bond market trends and equity sector leadership is a good way for investors to navigate a potential turn in the style cycle. From an equity strategist’s perspective, it still looks like a growth market.
The S&P 500® Index measures the performance of 500 U.S. large market capitalization stocks, and is intended to be a representative sample of leading companies across many industries within the U.S. economy.
The S&P 500® Information Technology Index is a subset of the S&P 500 Index, and measures the performance of leading companies within the U.S. tech industry.
The S&P 500® Financials Index is a subset of the S&P 500 Index, and measures the performance of leading companies within the U.S. financial industry.
The Russell 1000® Growth Index measures the performance of U.S. large market capitalization stocks with higher price-to-book ratios and higher forecasted growth rates.
The Russell 1000® Value Index measures the performance of U.S. large market capitalization stocks with lower price-to-book ratios and lower forecasted growth rates.
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