Dominance in the Stock Market

What do Facebook, Amazon, Netflix, and Google have in common? All are “growth” stocks and are currently dominating the stock market. Will these companies continue performing better than other companies, or will their “day in the sun” end?

Currently, the stock market is all about growth stocks. FANG stocks (Facebook, Amazon, Netflix, and Google), variants such as FANG+ and FAAMG (Facebook, Apple, Amazon, Microsoft, Google), and growth stocks in general are making the headlines. You don’t hear much about value stocks any more. So, what does that mean for good, old-fashioned value investing?

Growth and Value Investing Defined

“Growth” and “value” investing are the two primary investment philosophies today. Both seek to buy companies with promising futures, but differ greatly in what they’re willing to pay for these companies. Here’s a snapshot look at both.

In simple terms, growth investing entails selecting stocks with the potential for future, above-average earnings growth. Since buyers are interested in future earnings, the price they pay for these stocks is a secondary consideration.

Value investing involves buying stocks that are thought to be trading for less than they’re currently worth. For example, an investor might analyze a company along with its future cash flows and decide that the company is worth $100 per share. If the stock is currently selling at $80 per share (the farther below, the better), a value investor may buy it hoping the stock price will eventually reflect its assumed value.

The Dominance of Growth Stocks

Since the financial recession of 2008/2009, growth stocks have dominated the market and have greatly outperformed value stocks. From the end of 2008 through June 30 of this year, the large cap Russell 1000 Growth Index outperformed the Russell 1000 Value index by 3.5 percent per year. While 3.5 percent may not seem like such a big difference, it is. You have to consider the compounded interest to get the true picture. Compounded over 9 ½ years, an investment in the Russell 1000 Growth Index would be worth nearly 50 percent more than an equivalent investment in the Russell 1000 Value Index over the same time period. See why growth stocks are making the headlines these days?

It may be tempting to say that the current performance of growth stocks proves the superiority of the growth approach. But, hold on - not so fast. Let’s look back about 20 years, to another time when the world was undergoing rapid change.

The Tech Bubble

In the late 1990s, growth investing was also outperforming value investing by leaps and bounds. The internet was changing the world, and growth for companies in this emerging industry seemed limitless. Several well-known and widely respected value managers threw in the towel. They closed their funds, unable to make sense of a world that, to them, seemed to have lost its mind. The financial press was littered with stories featuring one central theme: Is value investing dead?

No, it wasn’t dead! It was just hibernating. After a third straight year of 30 percent + gains, the Russell 1000 Growth Index went into a tailspin. Beginning in 1999, it fell by more than 20 percent for the next three years. From 2000 to 2006, the Russell 1000 Value Index outperformed the Russell 1000 Growth Index every year. During that time the Russell 1000 Value Index more than doubled its return.

To Everything, There Is a Season

As the Byrds so eloquently put it, life is cyclical. It’s similar with investment styles. Growth and value both have their time in the sun, but neither will dominate the other forever – although if you’re the manager of the out-of-favor style, it sure can seem that way!

So, what does this mean for you? After such a long run of growth outperformance, it may be time to revisit your portfolio. Your growth-oriented investments may have increased in size relative to your value investments, and you may want to consider rebalancing. Selling a well-performing stock or mutual fund and buying one that isn’t performing as well seems counterintuitive, but that’s the essence of rebalancing. Just think of it as selling high and buying low. Hopefully, that will make it easier to take!

I firmly believe that value will once again have its day in the sun. When? I wish I knew, but that will be revealed only through hindsight. Believe me, there were no alarms ringing to tell us when growth investing’s late 1990s run was ending.

Summary

Growth investing has done extremely well since the financial recession, both on an absolute basis and relative to value investing. It may seem like this great run can go on forever, but given the examples of the past it seems unlikely. Review your portfolio and consider rebalancing.

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