What are the two most reliable return patterns in investing? Most would answer stocks outperforming bonds and low-priced value stocks outperforming higher-priced growth stocks. We’ve certainly seen a large premium for owning stocks over bonds for most of the last decade, what’s up with value?
First, let’s look at the long-term data. The Fama/French US Value Index has handily outperformed the Fama/French US Growth Index historically. The return for the Value Index was +12.8% per year versus just +9.7% for the Growth Index. This 3% per year spread is almost as large as the 4% per year difference between stocks (S&P 500 Index) and bonds (Five-Year T-Notes) over the same period.
The last 10 years has seen a different story, however. Growth stocks have outperformed value stocks. This trend started in 2014 but has really picking up steam since 2017. The last 12 months has been terrible for value--they've declined while growth stocks have gone up. Now we find that the last 10 years has been below average for the Value Index (+7.5% vs. +12.8%) and way above average for the Growth Index (+16% vs. +9.7%).
Why has this happened? Simple—Growth stocks have gotten crazy expensive. Yes, that’s a technical term. Their prices have grown much faster than their fundamentals have improved. As you can see below, the chart showing the stock valuations (price to book value) of growth stocks and value stocks is wider than it’s ever been, or at least as out of whack as it was in 2000. Value is about as cheap as it usually is, and growth is as overpriced as it’s ever been. The above-average gains for growth stocks have pushed up their prices versus their fundamentals to levels we’ve never seen before.
What does this mean? It’s obviously not good for growth’s future prospects. What happened the last time we saw growth stocks rise to the levels we see today? The chart above shows us it was the 2000 Tech Stock bubble. The next 10 years, reported below, were devastating for growth. Large growth stocks lost -11%, small growth stocks lost almost -14%. Large value gained +25% and small value gained over +192%. If we look at the large and small value indexes from Dimensional Fund Advisors, which are most similar to the funds we use, we find an even better value result -- the Dimensional US Large Value Index gained +50% and the US Small Value Index returned +225%. Want better value news? Consider that today, value stocks are even cheaper than they were in 2000!
But 2000-2009 is just one example, what does history show? There have been 77 different 10-year periods since 1927 (out of 1,100, or just 7% of the time) where the Fama/French US Growth Index has outperformed the US Value Index (see "Value" in the chart below). The next 10 years? Every single one saw value beat growth. Not some, not most. All. 77 for 77. The average of the next 10 years was a return of +8.3% per year more for value than growth. The best? +13% per year; even the worst 10-year period wasn’t bad—value beat growth by 2.9% per year. A similar bounce-back is evident when stocks underperform bonds ("Market") or small stocks trail large stocks ("Size").
Smart investors know that it doesn't pay to buy more of what’s done well recently, especially if that area of the market (bonds, or large stocks, or growth stocks) is a segment with the lowest relative long-term returns. With that in mind, is now the worst time in history to pile into growth stocks and give up on value?
It sure looks that way.
Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.