Wednesday, May 4, 2016

Growth or Value in a Low Growth Environment?

Financial Advisor Magazine recently published an article by the CIO of LPL titled 'Value Comeback' making the case for Value. There were some interesting points in the article connecting the recent growth outperformance with lower interest rates and/or oil, but the following point on low growth being a driver of the growth outperformance did not make much sense to me.

One of the main arguments against value (and in favor of growth) in recent years has been the slow global growth environment. When there is not a lot of growth in the economy or corporate profits, then it logically follows that the market would pay a premium for the companies that are generating growth (what we have referred to as motorboats, which can grow without a macro tailwind, as opposed to sailboats, which need economic growth to grow). 
The data support this. Over the past 25 years, when economic growth is slow (real gross domestic product [GDP] below 2.5%), growth outperforms value by an average of 4.1%, and beats value two-thirds of the time.
This caught my eye because in a previous post I noted that despite the outperformance of growth over the past 3, 5, and 10 years, it wasn't multiple related (i.e. investors have not paid a larger premium for growth stocks). In fact, growth stocks have gotten relatively cheap by the measure of forward P/E (the current premium is about 20% for growth vs. the 30 year average of ~40%). In addition, I always assumed that growth did better during strong periods of high growth because that's when optimism tends to be highest and growth stocks become bid up during that exuberance (i.e. the roaring 90's).

So I ran the numbers for the same period that was reflected in the article, looking at Russell 3000 Growth and Russell 3000 Value (all cap indices) as my growth and value proxies. I then annualized the performance for each quarter when real GDP was < 0%, between 0% and 2.5%, between 2.5% and 5.0%, and 5%+. The results show value has historically done better in all environments EXCEPT when growth was quite high (above 5%).

Much of the historical outperformance of value did coincide with much higher valuations for growth stocks, so past outperformance of value vs growth may not happen even if growth remains sluggish going forward. In addition, the depressed price of commodities (due to the global slowdown) may make value (where most energy companies are classified) as the place to be if the economy expands quickly, However, it does clearly show that economic growth has been good for stocks in general and high levels of economic growth have historically been especially good for growth stocks.