Growth is currently outperforming
The below graph reflects the severity of the “growth stock bubble” that occurred until 2001. Value stocks, and value investors, like the legendary value investor Warren Buffett of Berkshire Hathaway, were left in the dust as growth rallied hard, and value was left in the dust too. This article illustrates the extent to which growth stocks can, and have, drastically outpaced value stocks for short periods of time, though they can also be absolutely clobbered when an investment theme or business cycle changes.
For an overview on these risk factors, please see Key strategy: 4 key risk factors as the Fed tapers.
Value stocks tend to hold up better in declining markets
As the above chart reflects, during weak equity market periods, such as the Dot Com crisis of 2002 or the financial crisis of 2008, value stocks held up better than growth stocks, and they tend to do so when the future direction of the economy looks bleak.
Value investing for downside protection in a rising rate environment
As a result, investors concerned about a major decline in global equity prices or suddenly weakening economic data may wish to consider weighting value shares over growth shares in their portfolio. Perhaps the post-2008 recovery that favored growth over value may be a little long in the tooth.
Alternatively, if investors are confident that global economic growth will remain firm, and that earnings will remain strong, an allocation to growth stocks over value stocks may be more appropriate. Given the large long-term outperformance of value relative to growth, it may be possible that that growth has more room to outperform and to shrink its long-term underperformance relative to value. So the post-2008 outperformance of growth may continue. However, if data weakens, that may put a damper on the future prospects of growth outperforming value.
To see how the fourth factor, momentum, can affect your portfolio’s returns, please see the next article in this series.
Equity outlook: Constructive macro view
Despite problems in Ukraine and China, and despite the modest consumption data in the USA, U.S. labor markets appear to be well into recovery—with the exception of the long-term unemployed. From this perspective, it would appear that the U.S. is probably the most attractive major investment market at the moment. While the fixed investment environment of the U.S. is still quite poor, corporate profits and household net worth have hit record levels. Hopefully, all of this wealth and liquidity can find their way into a new wave of profitable investment opportunities and significantly augment the improvement in the current economic recovery. For investors who see a virtuous cycle of employment, consumption and investment in the works, the continued outperformance of growth stocks over value stocks could remain the prevailing trend, favoring the iShares Russell 1000 Growth Index (IWF) and growth-oriented companies such as Google (GOOG) or Apple (AAPL).
Equity outlook: Cautious macro view
Given the China- and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index (IWM), the State Street Global Advisors S&P 500 SPDR (SPY), the Dow Jones SPDRs (DIA), and the iShares S&P 500 (IVV). Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples–related shares, as reflected in the iShares Russell 1000 Value Index (IWD), such as Walmart (WMT).