Tuesday, October 23, 2018

Market rout may spur rotation from growth to value

Photo: Pixabay.com/nattanan23
By Charles Roth, Guest Columnist

The early-October 2018 selloff in stocks has fueled speculation about an incipient rotation from growth to value. After a decade of growth stocks beating asset-heavy, stable earners and cyclical industrials, perhaps it’s time for a rebound in value. Recent exchange-traded fund flows and value vs. growth index returns suggest a shift in investor sentiment.

Since 2008, the S&P 500 Index has returned an annualized 14%, driven largely by large-cap growth. Corrections should be expected and welcomed. They create better price values for risk assets. Value can be assessed at the individual security or index levels, though we think it’s easier at the security level. Correctly timing index mean reversions is extraordinarily hard. It can look easy in hindsight, but head-fakes abound.

Take the Russell 1000 Value Index (RLV) relative to the Russell 1000 Growth Index (RLG), and the inverse RLG/RLV ratio. The mean reversions appear clear: as the Federal funds rate and the 10-year Treasury yield zig-zagged down from 1981 to 2008, value outperformed growth point-to-point. Over those nearly three decades, though, value outperformed in the first 10 years, then mostly lagged in the prelude to the Tech bubble. After that burst, value resumed beating growth until just before the Financial Crisis.

From the bottom of the Financial Crisis, growth then shifted into overdrive. It was fueled partly by unprecedented monetary policy: a ground-level benchmark rate and central bank asset purchases, which kept long-term rates at lowly levels for years to come. Until, perhaps, this fall, when the U.S. 10-year Treasury yield jumped about 40 basis points to around 3.20%. From September 11 to October 10, 2018, the Russell 1000 Value and S&P 500 Value indices both beat their growth counterparts by well over three percentage points.

Click chart to see enlarged image.

So declining Treasury yields combined with falling household savings created tailwinds for expanding consumption that boosted industrials, staples and infrastructure companies. But the Financial Crisis then induced consumer deleveraging. And tech’s intangible assets—intellectual property and patents—in many ways became more valuable than the fixed assets of old economy companies.
That’s reflected in index restructurings. The S&P Dow Jones and MSCI recently replaced the old telecommunications sector with a new “Communications Services” sector.

A quarter-century ago, the telecommunications sector was 9% of the S&P 500 Index, but by the end of August it had dwindled to less than 2%. Meanwhile, information technology’s weighting went from 6% to 26%, not including tech giants Amazon and Netflix, which were classified as consumer discretionary. Tech behemoths are now divided into three separate sectors. Big firms that own telecom and cable “pipes” are trying to leverage them with more valuable media and content offerings. The new communications services sector is 10% of the index.

Now, as rates rise valuations matter more. Whether growth or value stocks, if a company’s share price significantly diverges from its business fundamentals, opportunities to buy or sell are created. We think these are easier to spot than true index mean reversions.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Thornburg Investment Management or TEXPERS.

Charles Roth
About the Author:

Charles Roth is global markets editor for Thornburg Investment Management. Prior to joining Thornburg in 2013, he was an assistant managing editor at Dow Jones Newswires, the Wall Street Journal’s real-time financial news and analysis division, where he oversaw its bureaus in Latin America as well as the New York–based emerging markets group. He previously served as a senior writer in the emerging markets group, bureau chief in Venezuela, and staff reporter in Malaysia. Roth earned a bachelor's degrees from the University of Colorado at Boulder and an masters' degree from the Instituto Universitario de Desarrollo y CooperaciĆ³n at the Universidad Complutense in Madrid, Spain. He was a Peace Corps volunteer in Mali.

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