With the recent downturn in the markets and the ongoing issues we will be facing as a result of the coronavirus pandemic, many are asking if we have reached an inflection point in the market when value stocks will begin to outperform their growth counterparts. Growth stocks have been on an extended, decade-long run since the market recovered from the global financial crisis in 2009.
On the Global Equity team, our answer to that question is an emphatic “No.” We think, in the years ahead, growth will continue leading the market. There are several reasons for our confidence in the potential of growth stocks to continue outperforming.
First and foremost, we believe events don’t change trends. Events such as the coronavirus pandemic may either accelerate or slow them down, but the overall structural trends that have been shaping the global economy over the past decade, supporting some activities and depressing others, will continue, in our view. During this crisis, we can see many of them accelerating. Working remotely is one example, purchasing items through the Internet and having them delivered, rather than going to brick-and-mortar stores, is another. So, too, is engaging with colleagues, family and friends more visually through video conferencing, rather than simply texting, emailing, or phoning one another.
These are obvious examples we can see in our everyday lives. There are other, more specialized examples. Technology is also revolutionizing health care. For instance, gene sequencing will enable us to realize faster diagnostic results and ultimately faster development of drug and vaccine therapies. Analysis of big data will help improve medical diagnostics and public health care planning. These are just some of the trends that growth portfolio managers were already investing in, and which the coronavirus pandemic will likely accelerate, in our view.
Other trends, like the rise in mass affluence, may be slowed by the current economic setbacks around the globe, but we don’t think that trend will stop once economies regain their footing. Similarly, the aging of populations around the world won’t reverse course, and we believe that all the industries that cater to older populations – everything from travel and leisure to health care – will continue to benefit from this demographic shift.
Our confidence in growth also stems from the extensive upside potential these trends offer. The upside is more limited for value managers. They typically invest in cyclical stocks during the down phase of their cycle, when their stocks have become cheap, or in companies that have experienced a decline or setback that may temporarily depress their prices. In these cases, the upside comes from the stock prices being able to rebound to their historical mean. While skillful value managers have the potential to generate attractive returns for their investors by careful stock-picking and good decision-making about which companies have the potential to rebound, and when the best times to buy and sell them are, the upside potential generally has a ceiling. That ceiling may be hit when a company’s business cycle reaches its peak or when another’s turnaround becomes fully reflected in its stock price.
We believe the ceiling is lowering in many of the cyclical industries usually suitable for value investing because many are “20th-century industries” whose best days are likely behind them, in our opinion. These include industries that are being disrupted, such as brick-and-mortar retail by online shopping, or oil and gas production and refining, coal mining, and fossil fuel-reliant electrical power generation, all of which are threatened by ever-cheaper renewable energy. This group also includes industrial commodity producers that experienced a “once-in-a-century” super-cycle of demand vs. supply bottlenecks caused by the sudden industrialization of China. The latter gave the commodity producers unusual pricing power that has more recently dissipated as new capacity has come on stream. We believe it’s unlikely these firms will have that level of pricing power again in our lifetimes, and that impacts industries ranging from mining iron ore, nickel and bauxite to smelting steel and aluminum.
The growth prospects are more limited for these mature industries. Growth managers tend to be more focused on the “21st-century” industries such as technology or biotechnology, where breakthroughs are continuously opening new doors for expansion and demand is growing faster. Put simply, it’s easier to make money in a growing industry than in a declining one.
We do think that as the market recovers, value stocks could outperform growth names for a quarter or two, much as we saw in 2014, as their valuations rebound from despairing levels. But periodic valuation recovery is not the same as market leadership which, over the longer term, depends on economic leadership. The key point, once more, is that we believe events don’t change trends. The forces of mass affluence, new technology, and aging that were restructuring the world economy before the coronavirus outbreak are still at work, pressuring change through this crisis and, we believe, for many years after we emerge from it. The most skillful growth managers should be able to capitalize on those trends.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
A value investing style subjects the fund to the risk that the valuations never improve or that the returns on value equity securities are less than returns on other styles of investing or the overall stock market.
The opinions referenced above are those of the authors as of May 6, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.