What to Expect from Value Going Foward + Market Update + 11.14.23
Josh Jenkins, CFA, Chief Investment Officer, Principal
November 15, 2023
Last year, value stocks did considerably better than growth in what was a very volatile period. While many investors expected that trend to continue into the current year, that has not been the case. A key factor in this reversal has been a handful of large growth stocks, dubbed the Magnificent 7, that have seen explosive gains during 2023. As a result, any strategy that has tilted away from these stocks has trailed considerably. By some measures, value companies have lagged growth by over 20% during the first half of the year. What should value investors expect after such a dominant period of performance for growth stocks?
The chart below, from Dimensional Fund Advisors (DFA), provides some historical context. It demonstrates the performance of value following periods of significant under or outperformance relative to growth. The analysis defines a significant performance of one versus the other as 20%+/- in a two-quarter period.
They found that, including the most recent episode, there have been ten total instances where growth has outperformed value by 20% during a two-quarter period since 1926. This suggests that the recent spat of value weakness is not unprecedented. Meanwhile, value has outperformed growth over a two-quarter period by at least 20% on 19 different occasions. So, periods of significant value outperformance have historically been more likely than periods of value underperformance.
Source: Dimensional Fund Advisors. In USD. July 1926–June 2023. Quarterly returns for value and growth based on the Fama/French US Value Research Index and the Fama/French US Growth Research Index, respectively. Data provided by Fama/French. The Fama/French indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment.
A few additional observations from the chart:
Of the nine instances of substantial value underperformance (grey bars), value outperformed growth during the subsequent year on seven occasions. Value outperformed growth in those seven instances by 29% on average.
Of the nineteen instances of significant value outperformance (blue bars), value outperformed growth during the subsequent year on eleven occasions. Value outperformed growth in those eleven instances by 3.6% on average.
The key takeaway is that when value underperforms substantially, it tends to snap back in a major way. When value outperforms substantially, there is still a good chance it will continue to outperform. This is not a bad tradeoff and is not surprising, given that value has outperformed over the long term.
While it can be uncomfortable to maintain a value tilt during a period where the style is lagging, investors are best positioned to earn the value premium when they maintain the tilt over time. The premium return generated by value can show up without warning and in dramatic fashion. Investors want to be sure they are in their seats when it does.
Week in Review
The Bureau of Labor Statistics published an updated report on inflation early Tuesday morning. The Consumer Price Index (CPI) cooled from 3.7% year-over-year (YoY) in September to 3.2%, which was lower than expected. Declining energy prices during the month contributed to the decline. Core inflation, which removes the volatile food and energy components, also cooled more than expected. Core inflation fell to 4.0% YoY versus economist’s expectations of 4.1%.
Following the CPI report, there was a sharp rally in both the stock and bond markets. Investors are now effectively pricing in the end of monetary policy tightening, which seems like a reasonable expectation so long as inflation does not begin to heat up again. The 10-year Treasury yield declined roughly 0.20% to close at 4.45%. The S&P 500 index gained 1.9%, while the small-value stocks of the S&P 600 Value Index spiked by 5.6%.
According to FactSet, 92% of the S&P 500 has reported Q3 results as of last Friday (11/10). The earnings growth rate, blending companies that have already reported with the estimates for those that have yet to report, is at 4.1% year-over-year. Expectations for the earnings growth rate at the onset of earnings season was -0.3% year-over-year. If the blended-rate estimate comes to fruition, it will be the first quarter of year-over-year earnings growth for the S&P 500 since Q3 of 2022.
Inflation Was Flat In October From The Prior Month, Core CPI Hits Two-year Low (CNBC)
Josh Jenkins is a Chief Investment Officer and Principal at Lutz Financial. He began his career in 2010. Josh leads the Investment Committee and specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. He is also responsible for portfolio trading, research and thought leadership, and the division's analytics and operational efficiency. He lives in Omaha, NE.
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