Value’s Big Surge – Has It Gone Too Far?

March 25, 2021

You may remember us writing about “The Return to Value” in our December 2020 Wealth Watch. In that edition, we mentioned the developing rotation from high-flying growth stocks to value companies. That trend continues today in strong fashion. The question is, can it last? History suggests it certainly can.

The Value Premium

You hear us talk about the value premium quite often. There is pervasive evidence that value (cheap) stocks outperform growth (expensive) stocks over time. According to Dimensional Fund Advisors (“DFA”): “data covering nearly a century in the US, and nearly five decades of market data outside the US, support the notion that value stocks—those with lower relative prices—have higher expected returns.” Essentially, if you pay less for one stock vs. another, you win over time.

Therefore, it seems obvious. Tilt the portfolio toward value and reap the reward. Unfortunately, there is no free lunch. To capture this premium, investors must endure some level of tracking error. Or, in other words, periods of underperformance.

The first nine-months of 2020 were a perfect example, as value companies were hit extremely hard by the pandemic. Airlines, hospitality, retail and particularly energy suffered tremendously as people began staying home and individuals and businesses turned to online communication and shopping platforms.

As the prospects for a post-coronavirus world improved, we have seen that trend reverse. Value companies, particularly small value as represented by the Russell 2000 Value Index, have significantly outperformed:

Source: Ycharts – Data from 10/1/2020-3/17/2021

We should not be surprised by this, as valuations eventually matter. Value stocks were at the cheapest level relative to growth since the Great Recession:

Source: JP Morgan 12/31/1997 through 12/31/2020

Note the shaded areas that represent past recessions. Value performed quite well after these periods.

Pandemic Plays

Companies that emerged as winners during the crises like Netflix, Zoom, and Amazon significantly outperformed the first nine months of 2020:

Source: Ycharts – Data from 12/31/2019-10/01/2020

Investors tend to extrapolate the past, however, and the following underscores the importance of diversification. All of these companies posted negative returns since 10/1/2020 and significantly lagged the growth index, which has in turn lagged value indexes:

Source: Ycharts – Data from 10/1/2020-3/17/2021

The Biggest Names Underperform

What about other big names besides Amazon, such as Apple, Microsoft and Facebook? Only Microsoft slightly outpaced the growth index since 10/1/2020. The rest have underperformed.

Source: Ycharts – Data from 10/1/2020-3/17/2021

History suggests this trend could continue. According to DFA, from 1927 to 2019, the average annualized three-year return for stocks before joining the Top Ten in size was nearly 25% higher than the market. Five years after joining the Top Ten, they underperformed the market on average. That gap was even wider ten-years out.

Source: Dimensional Fund Advisors

Some investors argue that today’s growth stocks are less risky because many are profitable with strong balance sheets. But even if a company has strong fundamentals, it is not bulletproof, especially if valuations are stretched. It can underperform for a long time if the expected earnings (or higher interest rates in today’s recent market) can’t support the valuations. An investment in Microsoft in late March 2000, one of the strongest companies coming out of the tech bubble, took nearly 14 years to recoup:

Source: Y Charts 3/30/00-3/1/2014

If history is any indicator, the economic recovery should continue to broaden beyond growth companies. Value, while having surged as of late, long-term evidence supports it may still have a way to go.

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Future performance of any investment or wealth management strategy, including those recommended by Balasa Dinverno Foltz LLC (BDF), may not be profitable, suitable for you, prove successful, or equal historical indices. Historical indices do not reflect the deduction of transaction, custodial, investment management fees, or fund fees, which would diminish results. Any historical index performance figures are for comparison purposes only and client account holdings will not directly correspond to any such data. BDF clients must, in writing, advise BDF of personal, financial or investment objective changes and any restrictions desired on BDF’s services so that BDF may re-evaluate its previous recommendations and adjust its investment advisory services. BDF’s current written disclosure statement discussing advisory services and fees is available for review at or upon request.

Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from BDF.

The Russell 2000 Index® measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

The Russell 1000 Growth Total Return Index measures the performance of growth stocks drawn from Russell 1000 index. The complete market capitalization of Russell 1000 index is divided into growth and value segments by using three factors: price to book ratio, forecasted growth and sales per share growth. The index is market capitalization weighted

The Russell 1000 Value Total Return Index measures the performance of value stocks drawn from Russell 1000 index. The complete market capitalization of Russell 1000 index is divided into growth and value segments by using three factors: price to book ratio, forecasted growth, and sales per share growth. The index is market capitalization weighted.