INSIGHTS

On June 12, 2017

AAM Viewpoints – Time to Dial Up Value Exposure?

It has been tough sledding for Value stocks in 2017. The Financial Times recently noted, “U.S. growth stocks are now thumping their value counterparts by the most since 2000.” This comes on the heels of 2015 which will forever be known as the year of the “FANG” stocks, when Facebook, Amazon, Netflix, and Alphabet (Google) famously (infamously?) accounted for essentially all of the S&P 500 Index’s total return for year. At the time, one could argue the focus on large-cap growth stocks was warranted given the environment. The price of oil had collapsed and concerns about a global slowdown played out via an earnings recession that lasted six quarters. In a low-growth environment, investors put a premium on companies who could continue to grow in spite of waning macro-economic trends; the FANGs were a logical conclusion.

The following year there was somewhat of an equal-and-opposite reaction as Value stocks more than doubled Growth stocks. The S&P 500 Value Index had a total return of 17.39% compared to the S&P 500 Growth Index total return of 6.89% in 2016.

The FANGs, Growth stocks, and narrow market leadership are once again making headlines in 2017 as five companies account for over one-third of the S&P 500 Index total return. Apple, Amazon, Facebook, Microsoft, and Alphabet are up an average of 29% year to date compared to the S&P 500 Index at 8.94%, while the S&P 500 Growth Index has a price return of 14.43% compared to the S&P 500 Value Index price return of just 2.76% (as of 6/2/2017). But is the outperformance warranted this time, and will it last?

The chart below we use to illustrate relative strength between the two groups (growth vs. value). It shows the S&P 500 Citigroup Pure Growth Price Index relative to the S&P 500 Pure Value Price Index, in this case over the last eight years to cover the current bull market run. As you can see the chart hit its peak in 2015 (the year of the FANGs), followed by a strong correction in 2016, and finally the current trend in 2017 where Growth stocks are once again outpacing Value and fast approaching bull market peak levels. This suggests significant relative “value” in Value stocks.

Source: FactSet

Stocks such as Facebook, Amazon, and Alphabet will likely still be rewarded if they can continue to grow revenues and earnings at an above-average rate. However, current valuations coupled with a firm economic backdrop suggest Value stocks could be positioned to perform well over the next 12 months and perhaps close the gap between their Growth counterparts.

On the micro front, companies in the S&P 500 grew their earnings 14% in the first quarter (year over year), the highest growth rate in over five years, and analysts are calling for earnings per share (EPS) growth of 19% over the next 12 months. Internationally, the projections are even higher with the aggregate EPS growth estimate for the MSCI ACWI-Ex U.S. Index currently at 31% (Source: Bloomberg). On the macro front, the Trump Administration is hopeful a combination of tax relief, healthcare reform, reduced regulation, and infrastructure investment can boost GDP growth to over 3%.

All this to say if corporate earnings and global growth can continue to trend higher look for the “growth premium” to disappear as there should be enough to go around. We would expect cyclical sectors with a Value tilt to be the beneficiaries such as Materials, Industrials, and Financials and dividend payers.

Clearly there have been some sharp swings in relative performance for Growth and Value styles over the past couple years. The rotational nature of the market calls us to remain committed to a diversified investment approach. Having the discipline to maintain exposure, or even dial up exposure, to underperforming areas of the market can be difficult – in this case Value stocks – however, it is our belief staying invested in the market according to a strategic allocation over long-term horizons may add value by enhancing portfolio returns and/or reducing portfolio risk.