The Inevitable Decline of Growth Stocks (for Now)

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In my June 2020 Asset Class article titled “Preparing for the Turn,” I wrote: 

Any investor thinking about giving up on large and small value stocks after this late-in-the-game rally by large growth stocks (represented by the S&P 500 Index) should study the chart and tables below very carefully. 

In my January 2021 article titled simply “The Turn,” I wrote: 

Small cap and value stocks have surged over the last few months in a welcoming indication that we’re experiencing the turn in asset class leadership I wrote about last June. As an all-value investor, I’m certainly feeling better about my portfolio and I hope you are too. 

These articles were consistent with the style of communication we’ve used with clients since 1993, which is centered on developing and maintaining realistic expectations about asset class performance and risk. 

Most of our clients own an allocation to large growth stocks through an S&P 500-type index fund or similar US large company asset class fund. Because we know the wide swings in relative pricing this asset class experiences over time (see Table 2), our messaging is designed to encourage rebalancing— maintaining a consistent risk profile for the portfolio which the Equius team does so well, and discourage market timing, which is so potentially destructive to the long-term growth of a well-diversified portfolio. 

Yet, despite our consistent messaging and application of our investing principles, cycles like these always present our toughest challenge. The allure of big-name “glamour” companies dominating the mainstream and financial press is often more than the average investor can resist. The higher their prices rise, the more attractive they become to some people. They turn investors into speculators. 

It’s crazy stuff, but it’s stuff I’ve been dealing with for decades. Our next-gen Equius team now has one of these cycles under their belts, and because of their devotion and hard work, our clients are better off for the experience. Clients we’ve saved from themselves know who they are and know the amount of wealth that has been preserved and that continues to grow as a result of these efforts. 

I won’t remind you of the details that led up to the dot-com crash of 2000 and the subsequent “lost decade” for large growth stocks from 2000 to 2009. But I will remind you that smaller, lower-priced US companies performed better than large, high-priced US companies for 9½ years after the market recovered in March 2009. It was only three years ago (March 2019) when performance crossed over and large growth stocks took the lead. The way things are going, it wouldn’t surprise us if those lines crossed over soon and the higher expected returns of small value stocks become higher actual returns. 

The surge in US large growth stocks appears to have been driven largely by the economics of the COVID-19 response. That ship has sailed. Zoom peaked in price on October 16, 2020, and has gradually fallen from $559 to $142 per share today— a decline of 75%. Netflix peaked at $692 on November 17 last year and is at $355 today—a decline of almost 50%. I could go on. 

Equius has always recommended an allocation to US large growth stocks for diversification reasons. We know they have lower expected returns than large and small value stocks, but cycles like the one shown in the “Growth of $1” chart illustrate our point. 

Unfortunately, some investors ignored the value of the first 9½ years shown on the chart—when value stocks carried the portfolio—as soon as the big household names started dominating the media narrative. FOMO—the fear of missing out—is a powerful force that must be reckoned with. 

Personally, my fear of missing out is related to the higher compound returns offered by value stocks both in the US and the foreign developed markets. I want those returns, in larger quantity than the average investor, and am willing to be patient to realize them. 

Asset class investing is really all about personal preferences. The risk/return “dials” are not super precise, particularly since time is an input, but they work pretty well over a typical investor’s investment time horizon. Your portfolio should reflect your preferences. 

I’ll close with a comment on the foreign stock dial of the portfolios. Foreign stocks have lagged US stocks pretty significantly since 2009. But they’re staging their own comeback (finally!), especially on the value stock side. So, as always, I believe patience will be rewarded. 

The chart below is not a performance chart but rather a tracking of the price-to-book ratios for US value and growth stocks (across all size dimensions). The lowest line (light gray) shows how this important metric has changed over time for a portfolio of US value stocks—which hasn’t been much given the structure of these indexes/funds. The performance of a portfolio of value stocks is driven primarily by individual stocks that rise in price (usually due to improving business management) and are then sold out of the portfolio, so that the investor realizes the gain. The highest line (dark gray) tracks the change in price-to-book for US growth stocks (which tend to stay in index/fund portfolios no matter how expensive they become, so investors ride them up and down), and as you can see, that metric is at an all-time high—surpassing the level at the peak of the dot-com era of the late 1990s. Finally, the blue line shows the spread in relative pricing between US growth and value stocks—also at a historical high—as of last October.

Equius Partners, Inc. is a Registered Investment Advisor.

Past performance is not a guarantee of future results. The data and information set forth herein are provided for educational purposes only and should not be considered tax, legal or investment advice; a solicitation to buy or sell securities; or an opinion on specific situations – as individual circumstances vary. There is no guarantee an investing strategy will be successful. Investing involves risks, including possible loss of principal. Diversification does not eliminate risk, including the risk of market or systemic loss.

Please consider the investment objectives, risks, and charges and expenses of any mutual fund and read the prospectus carefully before investing. Indexes are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

© 2023 Equius Partners, Inc.

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