Has the drought for the large-cap value risk premium run its course in the US stock market? Reviewing recent history suggests a cautious “yes,” based on comparing the rolling two-year cumulative performance spread for the Russell 1000 Value Index less the Russell 1000 Growth Index.
Since March 2008, large-cap growth has delivered superior performance relative to value stocks. Suffice to say, growth has had a good run. A $100 investment in the Russell 1000 Growth Index on March 31, 2008 would have grown to $135 on a total return basis through the end of last month (January 31, 2013). By contrast, a $100 investment in the Russell 1000 Value Index, by contrast, would have increased to $120 over that span.
But that was then. Is the dynamic set to turn in favor of value stocks? The answer will be obvious only in hindsight, of course. But history reminds that there are cycles to value and growth, with one or the other dominating for extended periods, as the chart above shows. Accordingly, it’s reasonable to expect that growth cycle will end… one day. Exactly when is debatable.
One reason why this cycle exists at all may be partly due to behavioral reasons. It’s always difficult for the crowd to consider that a long-running trend has ended. Recall that the previous run of relatively weak performance for value stocks in the late-1990s was accompanied by cries that this risk factor had permanently crashed. Growth at the time was all the rage, and some value-oriented managers threw in the towel. Others changed strategies and gravitated toward growth. It all looked quite sensible. Growth, after all, had been the dominant risk factor.
But just when it seemed that the case for value investing was dead, the zombie emerged from the grave. For roughly eight years, starting in early 2001, large-cap value stocks beat their growth counterparts.
Then in early 2008, the trend reversed again, and growth became the leader. Five years on, the question is whether the cycle is set to reverse once more? No one really knows, of course, although the possibility that we’re at a turning point looks a bit more plausible these days. The two-year return spread between large-cap value and growth stocks has been roughly even so far in 2013, with a small bias in favor of value. Is this a pause before growth resumes its dominance? Or is value about to lead anew?
Minds will differ, as always, in real time. What to do? If you have a dedicated allocation to value and growth, no doubt your growth stocks are above their target weight, assuming you’ve held the portfolio for several years and let it wander at Mr. Market’s discretion. If you haven’t rebalanced recently on the value/growth axis, now’s a good a time as any. Unless, of course, you’re confident that growth will continue to outperform.
Update: The original chart posted above mistakenly labeled the return spread as a rolling 1-year difference. In fact, the chart depicted a rolling 2-year cumulative spread. The wording in the chart has since been corrected, along with references in the text. Otherwise, the graphic aspect of the chart is unchanged. Sorry for any confusion.