Historically, value stocks have outperformed growth stocks, but that hasn’t been the case in the past several years.
That changed in July when the Russell 1000 value index put in its best month for 2018, versus the Russell 1000 growth index. That caused some market watchers to ponder whether or not the value style of investing is finally turning a corner.
But one month can be a fluke, and several investment strategists say they don’t see growth stocks handing the baton over to value just yet as the business cycle is expected to stay strong for some time.
A tech pullback. Jeff Mills, co-chief investment strategist at PNC Financial Services Group in Philadelphia, says he does not see a shift to value coming anytime soon, calling the July outperformance “idiosyncratic.” He says tech-sector stock weakness was behind value’s gains and the current economic conditions don’t favor a switch to value from growth.
[See: 7 Value Stocks With Growing Dividends.]
“Going back throughout time, [if] you look at periods when value tends to do the best … oftentimes it’s coming off the bottom after a recession and you get this reacceleration in growth,” Mills says.
The reason why growth stocks have done so well in the recent economic expansion is that the U.S. was in a slower-growth environment.
“Throughout this recovery, it’s been an economic cycle that’s really been void of that typical acceleration that you see a during robust economic expansion,” he says. “So that’s why investors have been so persistent in seeking out companies that are able to grow versus value companies.”
Mills says with the economy in the late-stages of a business cycle, growth companies tend to perform the best, and he thinks that the growth style will continue for the rest of the cycle.
“You may have a time when value outperforms for a period,” he says. “But overall I don’t think we’ve reached some seminal moment where all of a sudden it’s now a value’s day again.”
Craig Callahan, president of ICON Advisers in suburban Denver, says he thinks the current bull market in equities can go another year or two. Even though sectors like consumer discretionary and technology have been big winners in the recent rally, Callahan says he expects that to continue.
ICON uses intrinsic value to estimate stock value, rather than a typical price-earnings ratio, he says, and based on that he says markets have room to rise.
“We still see stocks on average to be 2 percent below our estimate of fair value,” he says. “And that’s nowhere near the overpricing typical market peaks. In our view, we’re not seeing the emotional, optimistic, greedy type of behavior we see at peaks.”
Market timing. Tim Courtney, chief investment officer of Exencial Wealth Advisors in Oklahoma City, says market participants are “really preoccupied with this idea that we’re in the late innings of this business cycle” and whether the current economic cycle will end this year or next year.
Since growth companies do well in late stages of an economic cycle, value companies can get hit pretty hard, so investors are trying to time the market to avoid getting into value too early, he says.
He says it may be too soon to say value has turned a corner, but the July performance by value is one of the largest outperformances over growth in a long time.
[See: 10 Value Stocks to Buy In an Unpredictable Market.]
July’s performance aside, Mills notes the differences between the value and growth, based on a forward P/E, still shows the Russell 1000 growth index is trading at the largest premium to the Russell 1000 value index since just after the global financial crisis.
Value could gain in the short-term if companies start increasing capital expenditures sustainably, and if that filters through to meaningfully increase productivity, allowing the economy to accelerate in a sustainable way, he says.
“You may see investors more attracted to value sectors because growth will be less scarce,” Mills says. “Investors may be less willing to pay that premium for growth. So I think it all centers around sustainable shifts in economic growth.”
Good news priced in. Although Courtney wouldn’t say growth stocks, especially in the tech sector, are priced for perfection, “the market’s reactions are something you would see in an asset class that’s got a lot of good news priced into it already.”
The recent stumbles by companies like Facebook (ticker: FB) which remains down after falling sharply following its poor second-quarter earnings in late July, is just one example, Courtney says.
“If there’s a flaw that gets exposed or that shows up in these companies, there’s quite a way to fall because so much enthusiasm and so much optimism is priced in,” he says.
Trip Miller, founder and managing partner of Gullane Capital in Memphis, says some value areas are picking up steam.
“Although the markets are hitting all-time highs, we still think there are a lot opportunities out there for companies that have just been left behind based on negative news in a strong economy,” Miller says.
One example is retailers showing signs of life after being beaten up for the past several years. A small-cap stock he likes is Destination Maternity Corp. ( DEST), which he says has a growing online presence in addition to physical stores. The company suffered from poor management, but he says that’s improving. He also says the retailer is in a “very recession-resistant business.”
He says investors need to be choosy in the sector. “Some stocks got beaten down just because they were in the retail sector and Amazon’s ( AMZN) going to hurt a lot of businesses,” Miller says. “Yes, it’s going to put a lot of businesses out of business. But I believe that all brick-and-mortar doesn’t go away and there’ll be some survivors and thrivers.”
Courtney says many of the value companies have “a good margin of safety” built in, with low P/E, such as in the financial sector, where many companies are trading with ratios well below the broader S&P 500.
[Read: What 8 Valuation Metrics Tell Us About the Market Now.]
There are also some concerns the impact of tariffs and trade wars may have on the market, he says. Tech companies derive about 60 percent of their revenues from overseas, the highest percentage of any other sector, he says, leaving them vulnerable.
“If you look at the price that they’re trading at, it doesn’t appear as though the risk of some kind of trade war breaking out is in the growth names and so they’re vulnerable,” he says.
More from U.S. News
The Top 10 Investment Portfolio for Millennials
7 Shipping Stocks to Buy for the Dividends
7 Ways to Shelter from a Trade War
Are Value Stocks Turning a Corner? originally appeared on usnews.com
