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Value Failed to Outperform Growth

Stocks came under selling pressure once again on fears of Omicron spread and the Federal Reserve’s plans to raise interest rates next year. Markets slumped to the start of an abbreviated trading week with S&P 500 Index (SPX – 4,568.02) falling 52.62 points or -1.14%, the Dow Jones Industrial Average (INDU – 34,932.16) tumbling 433.28 or -1.23%, the Nasdaq Composite Index (COMPQ – 14,980.94) finishing lower by 188.74 or -1.24%, and the Nasdaq 100 Index (NDX – 15,627.64) declining 173.82 or -1.10%.


The VIX index also rallied 1.30 to 22.87, rebounding from its 50-day ma (19.29) and 200-day ma (18.72). WTI Crude Oil (68.62) faltered, falling 2.11 or -2.98%. Despite the broad selling today, the 10-year Treasury yield (TNX – 1.419%) managed to close up 0.17 or 1.21%.


Fast-growing growth stocks have come under selling again because of rising interest rates amid rising inflation and economic growth. Based on a strong economy, you would expect growth stocks would appreciate much faster than value-related names. However, if strong economic growth leads to inflation and higher interest rates, this can hurt growth stocks that trade at high P/E and valuations. Higher interest rates and inflation means future profits and earnings are valued less today.

So, is buying cheaper economically sensitive, value-related names a better investment strategy today with the Fed scheduled to tighten and interest rates rising.


We decided to test this theory by comparing the benchmark 10-year US Treasury yield (TNX) against a ratio comprising of the S&P Value Index (SVX) divided by the S&P Growth Index (SGX).


The relative performance of SVX/SGX versus TNX over the past 30-plus years reveals the following:

S&P Value Index (SVX) outperformed S&P Growth Index (SGX) during 2000-2007. Yields rose dramatically from a low of 2.42% (Jun 2000) to a high of just above 8.00% (May 2007). The 10-year Treasury yield hovered just above 3.37-3.46% during the period.


S&P Value (SVX) underperformed S&P Growth (SGX) from 2007-present as rates plummeted from over 8% at the beginning of 2007 to a recent low of 0.55% (Jun 2020) soon after the Covid-19 pandemic induced recession.


In the past 13 years, TNX rarely traded above 3.04-3.46%. Except for the brief period during the Covid-19 pandemic broad market sell-off, rates maintained a floor near 1.46-1.51% for the bulk of this timeframe. Despite the sharp rise in interest rates since the 2020 bottom (0.55%), SVX/SGX ratio declined, establishing record-setting lower lows.


Over the post-war era, whenever TNX maintained below 3.00-3.5%, growth stocks have consistently outperformed value stocks returning higher returns and lower volatility. Value investing with an emphasis on less expensive, cyclical sensitive, and low-PE shares has consistently underperformed its growth peers.


The dominant and prevailing downtrend in the SVX/SGX ratio shows no signs of abating. Except for the brief relative outperformance cycle late last year on reflation interests, SVX/SGX continues with its primary downtrend. Based on the primary trend, growth shares can resume their outperformance cycle.


Some growth stocks with excessively high valuations may continue to sell-off. However, investors should avoid the urge to restructure their investment portfolio by selling all of their high-priced growth stocks as bond yields rise.


The value call may be a popular investment theme, but this could be a temporary near-term countertrend rally in the context of its prevailing intermediate-to-long term downtrend. The sweet spot in the marketplace remains high-quality growth names even if bond yields may be headed higher as the Fed taper next year and begin to tighten.


However, investors should also not be invested in all high-growth stocks as a balanced portfolio may provide the best means to diversify in the case of an increase in market volatility in the next few years.


Value shares have failed to outperform amid the recent rise in yields. Stock market returns may depend more on the specific level of bond yields than the near-term directional trend change in interest rates. Investors at the very least should wait until the 10-year Treasury yield exceed the 3.00-3.25% level before actively restructuring their portfolios to favor value over growth investing.



Source: Courtesy of StockCharts.com

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