There has been a wider-than-normal gap in the relative return between value and growth in recent years. Growth stocks, which include many of the big technology companies, powered the market higher for what felt like an extended period. More recently, however, there has been a shift as value stocks have taken the reigns. So far this year, growth has once again led the way. Now investors may be wondering if the strong relative performance of value has run its course.

The chart below, from Dimensional Fund Advisors (DFA), provides some context to the relative performance of value vs. growth. As the middle section highlights, growth had been on a tear relative to value. During the three-year period ending in June 2020, growth had outperformed by more than 20% per year. As the section on the right shows, value has seen a substantial resurgence, outperforming by roughly 22% annualized through the end of last year.

Exhibit 1: Recent Value Performance in Context

Annualized Returns, July 1926 – December 2022

Source: Dimensional Fund Advisors. Performance data shown represents past performance and is no guarantee of future results. Value and growth stocks represented by the Fama/French US Value Research Index and the Fama/French US Growth Research Index, respectively. 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. Returns provided by Ken French, available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to Dimensional Fund Advisors LP. See “Index Descriptions” below for descriptions of Fama/French index data.

Should investors expect value to remain on top? Or is it time to rotate towards growth? In the near term, anything can happen. The market is incredibly noisy in any given week, month, or year. Over longer horizons, however, there is evidence that might suggest how things will play out. As the left-hand section in the above chart illustrates, value has outperformed growth by about 3% per year on average over the last 90+ years. This well-known phenomenon is referred to as the ‘value premium.’ While value does not outperform all the time, it has historically outperformed over time.

Many investors possess a rational desire to tactically manage their investments. If neither value nor growth outperforms all the time, why not rotate between the two of them? The goal would be to tilt the portfolio to whichever investment style was doing well at the time. While this strategy is intuitive in theory, it’s extremely difficult to implement in practice. There is simply no reliable signal available to indicate when to make the switch from one style to the other. Those who attempt to time the market often end up performance chasing, which can result in repeated cycles of buying high and selling low. Not exactly a winning strategy.

The graph below looks at how value has done following periods of unusually strong and/or weak performance. The top portion of the graph illustrates the relative annual performance between value and growth each year since the 1920s. The bottom portion of the chart depicts the relative performance during the subsequent year.

Exhibit 2: Annual Value Premium and Following Year Value Premium

US Market, 1927-2022

Source: Dimensional Fund Advisors. Past performance is no guarantee of future results. Actual returns may be lower. Annual value premium is the return difference between the Fama/French US Value Research Index and the Fama/French US Growth Research Index. 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. Source: CRSP and Compustat data calculated by Dimensional. Fama/French data provided by Fama/French. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. See “Index Descriptions” below for descriptions of Fama/French index data.

As you can see in the chart, there is no observable pattern in subsequent year returns. The average return following a bottom quartile year (4.42%) is remarkably close to the average return following a top quartile year (4.49%). The key takeaway here is that recent performance does not provide useful information for what to expect going forward.

Of course, just because value has worked historically doesn’t mean that it will continue to do so. There is, however, a strong economic rationale for why investors should continue to expect a positive value premium over time. The price paid for an asset has a direct relationship with its expected return. All else equal, the lower the price, the higher the expected return.

Ultimately, there is no way of knowing whether value or growth will outperform during the next period. Still, the extensive historical record of the value premium, in combination with its sensible theoretical underpinning, likely provides investors a better way to establish long-term expectations than recent performance could.

WEEK IN REVIEW

• Last week the Bureau of Labor Statistics published updated Consumer Price Index (CPI) data. The headline figure surprised to the downside, rising just 0.1% MoM (5.0% YoY) vs. expectations of a 0.2% increase. Falling energy prices were a major contributor to the cooler-than-expected reading. Core CPI, which excludes the volatile food and energy segments, increased 0.4% MoM (5.6% YoY). The shelter component, which constitutes about 1/3 of the index, continues to put upward pressure on the rate of inflation, increasing 0.7% during the month. “Super-core,” which has recently been closely watched by the Fed, increased 0.4% during the month. This metric strips out food, energy, shelter, and other goods.
• Economic data due later this week includes jobless claims and US Leading Economic Indicators on Thursday, as well as the early readings on services and manufacturing sector activity on Friday. Additionally, there will be a handful of Fed officials speaking each day this week. Currently, the fed fund futures market is pricing in an 83% probability of a 0.25% hike at the next Fed meeting ending May 3rd.
• Earnings season kicked off last week with a few of the large Wall Street firms reporting. Coming into the end of the quarter, businesses in the S&P 500 are forecast to deliver year-over-year earnings growth of -6.7%. With the P/E on the S&P 500 already above average levels, earnings will need to turn positive in the coming quarters for stocks to continue higher in a sustainable fashion.

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MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION