Value vs Growth Investing: Is the Trend Changing?

By info@landmarkwealthmgmt.com,

Reversion to the mean is a phrase often used in investing.  It is the statistical phenomenon stating that the greater the deviation of a random variant from its mean, the greater the probability that the next measured variate will deviate less far from its mean.   In other words, an extreme event is likely to be followed by a less extreme event.  Sometimes in investing, these variations can be short term, and sometimes it can take years, or even decades.

Growth investing is about finding companies that are expected to grow their revenue or cash flows faster than the rest of the broader market, and hence their profits are expected to grow at a faster pace.   As growth is the priority, these companies reinvest earnings in themselves in order to expand, in the form of new workers, equipment, and acquisitions.

Value investing is about finding opportunities in companies whose stock prices don’t necessarily reflect their fundamental worth.  Value investors look for companies trading at a share price that’s considered a bargain.  As time goes on, they expect the market will properly recognize the company’s value and the price will rise.

The debate of value versus growth investing is one that has gone on for years.   There is no absolute definitive answer as to which is the better choice.   We’ve seen some data that suggest that given enough time value will outperform, but only slightly.  This was outlined in our September 2nd 2020 article, “Value vs Growth: Which is Better“.   However, that can be over quite a long period of time.  As we can see from the Bloomberg data in the chart above provided by First Trust Portfolios, value has lagged growth for the better part of 15 years until very recently.

The question today is whether this recent change is that inevitable reversion to the mean; or is the recent trend favoring growth stocks still in place?   That is a question that is impossible to answer with any degree of certainty, as is any short-term investment forecast.

Investors often choose between value and growth based on their personal goals.

Investors that want less volatility and more income will often choose the value investing approach.  Investors less concerned about volatility that are more willing to take on risk, and don’t need an income stream are more inclined to choose growth stocks for higher potential appreciation.   A well-balanced portfolio will typically have a reasonable exposure to both.  Choosing exclusively one over the other is a form of market timing that is quite difficult to predict.

While we don’t believe in or attempt to time markets, it is not unreasonable to presume that this trend may be changing.   This is not just due to the inevitable reversion to the mean.   It is also because there have been historically certain environments that have favored value stocks over growth stocks.   One such example is that value stocks have tended to outperform growth stocks when the yield on the benchmark 10-year Treasury note rises.  A declining 10-year Treasury note has favored growth stocks.    Currently, the trend is that the yield on the 10-year Treasury note is rising.  If this continues, this may favor value companies in the next several years.

The reason for this is that a company’s stock price is simply the value of future cash flows discounted by some interest rate.  A series of cash flows from company revenue that extends way into the future (the numerator), divided by an interest rate (the denominator), is a basic formula for discounting future cash flows back to today to give us a stock price.  The higher the denominator, the more it impacts the potential value of the stock.  Growth stocks are companies that are anticipating higher future cash flow, as opposed to value companies that are already discounted.

One can never be sure about a particular trend in the market, just as we can’t be sure of the trend in interest rates which play a role in the outcome of how these two areas of the market behave.   It was only in the year 2020 that growth stocks outperformed value stocks by the widest margin on record.  According to Morningstar, the average large cap growth fund returned 34.8% in 2020, while the average large cap value fund returned only 2.8% the same year.

This data from as recent as just 2020 could have easily led an investor to abandon their value stocks or funds out of frustration, and yet here we are in the first quarter of 2022 with the exact opposite result.

In the end, the best approach is always a diversified portfolio that maintains a good mix of dividend paying value companies along with a growth side of the portfolio.   Regardless of the asset class, given enough time, there will likely be a reversion to the mean.

 

 

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Military Conflicts: What is the Impact on the Market?

By info@landmarkwealthmgmt.com,

We often say that financial markets are the equivalent to a massive financial ecosystem in which no one event or action tells the entire story.   However, there are often singular events that can have a more substantial impact on the behavior and price action across the markets.  Sometimes these are positive events, and sometimes negative.   We tend to remember the negative events more than the positives, as is our nature as human beings.   This is particularly true when it comes to financial markets, since they tend to take the escalator on the upside, and the elevator on the downside.   As it pertains specifically to geopolitical events such as a military conflict, like every other event, they have had no substantive impact on the long-term returns of financial markets.

Looking at the above slide provided by Hartford Financial, we can see numerous military conflicts which have occurred since from World War II through the present day.   The data clearly demonstrates the nominal impact military conflicts have had on long-term results.

While it’s true that the longer-term impact has been essentially non-existent, that is not to say that the short-term impact is irrelevant.  We often discuss the risk of volatility in a portfolio, and particularly how it may impact the results of an investor that is currently dependent on their investments to generate an income stream.   A prolonged downturn can have an impact on such a scenario.

Let’s look at how well markets did in the immediate aftermath of some of these major events.

According to Morningstar and Ned Davis Research provided by Hartford, these are the annualized returns of the S&P 500 in the one, three, five and ten years following the below referenced events:                                                                                      

As we can see, in each of these examples, the three-year return was a positive annual return, with the exception of 3 periods.  One of which was 2008, which had little to do with the invasion of Georgia, and quite a bit to do with the global financial crisis.

What is clear from the data is that even in a relatively short period of time, markets tend to rebound significantly after a military conflict.   The above examples also assume a 100% exposure to the S&P 500 as your sole investment.   In reality, it is highly probable that anyone dependent on their portfolio for an income stream would own various assets, including that of fixed income which tends to be far less volatile in times of economic and financial stress.  As a result, the time it would take to recover from any portfolio losses is likely even further shortened.  Additionally, this data reflects only the price return of the S&P 500 and does not reflect the dividend yield, which would have turned the 3-year return following 1940 and 1973 into a net positive period.

None of this is meant to minimize the human cost of any military conflict and how it impacts those that are forced to endure the horrors experienced in the theatre of combat.  However, as an investor it is important to take into account the best way for you to proceed during periods of volatility regardless of the cause.

As long as markets exist, asset prices will rise over time.  Unless the next military conflict is a nuclear holocaust that wipes out the majority of the world’s population, or the free-market system is completely abolished and replaced with some form a centrally planned global state, then markets are likely to continue to rise.  Ultimately, as we often suggest, it is not wise to bet on the end of the world, since it only happens once.

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