Most of the clients of Emerald Asset Management are long term investors who want to participate in the growth of the economy by holding high quality stocks for the long term. That doesn’t mean buy and forget though. The goal is to identify primary market trends and to stay with those trends until fundamental and technical factors warrant making portfolio changes. We think that we are in the early innings of one of those changes right now.
Since the summer of 2007 growth stocks have generally outperformed value stocks. When Covid-19 reached U.S. shores, the rate of outperformance of growth over value only accelerated as investors were willing to bid up valuation multiples on growth stocks at the expense of value stocks. The reason is simply one of supply and demand, in our opinion. Keep in mind that, generally speaking, growth stock performance tends to be less dependent on a robust economy while value stock performance tends to be more economically sensitive. If earnings growth is scarce then companies capable of delivering reliable earnings growth should be expected to command premium multiples during periods of depressed earnings growth and that’s exactly what happened. Now the economy is reopening while global central banks continue to infuse massive stimulus into the financial system. Add to that the massive amounts of fiscal stimulus and a potential infrastructure bill on the way and we at least have the recipe for better economic conditions and that should favor outperformance by the more cyclical sectors of the economy.
That doesn’t mean we plan to sell all of our technology and healthcare stocks and put everything into industrial, mining and energy stocks though. And we don’t expect the shift from growth to value to take place overnight. We also don’t expect every quarter or even every year to be dominated by value relative to growth. After all, the underlying fundamental factors that underpin large cap tech and FANG type stocks haven’t changed in our opinion and we want exposure to some of the great growth stories. Rather, we favor more value-oriented, cyclical stocks for new investments while some profit taking in growth stock winners might be warranted.
Risks to our investment thesis include a resurgence of Covid - 19 and its variants, monetary or fiscal policy error and geopolitical events. But even if we are wrong about our shorter-term call on the direction of the economy, we still favor value over growth for the longer term for two reasons. First of all, historically when growth has outperformed value to this degree or vice versa, mean reversion has led to outperformance of the latter relative to the former. Secondly, as we have written extensively, we think that the longer-term risk to the direction of interest rates is to the upside. Interest rates started rising in 1950 and peaked in 1981. We think that the low price on the 10-year treasury yields at 0.39% in March of 2020 will eventually prove to be the low and that the interest rate cycle will eventually cause 10-year treasury yields to rise. Rising interest rates generally favor the stock prices of companies in more cyclical sectors.
Chart of the S&P Growth Index divided by the S&P Value Index. A
rising line indicates that growth stocks are outperforming value
stocks while a falling line indicates that value stocks are outperforming
growth stocks. The trend since 2007 has generally favored growth over value
but that could be about to change.