For the last decade growth stocks have outperformed value stocks, large-company stocks have outperformed small-company stocks, and domestic-company stocks have outperformed international-company stocks. This is not sustainable and it will end; the questions are, how and when will it end?
First, some background. As a reminder, growth and value are terms thrown around by people in the investing world to describe the two great philosophies of investing. The growth school suggests that an investor should favor companies that are growing their business more rapidly than the general economy. The value school suggests that all companies have intrinsic value that can be estimated, and if the stock is selling for less than that amount, it is a good investment. We often use the example of shoppers: Growth investors want the latest and greatest fashion and are willing to pay in order to get it, while value investors want bargains.
In reality, all great investors, like good shoppers, are a bit of both. One may lean more towards value or more towards growth, but no one wants to overpay or buy the stock of a company that cannot grow its business.
One will often hear the terms growth stock or value stock, but these are simply descriptions of the typical stocks favored by growth and value investors, respectively. Trust me, no board of directors has ever met and said, “This company should be priced as a value stock.”
Large versus small is clearer, although keep in mind this is all relative. These are all publicly traded companies, so none of them are that small. Likewise, international versus domestic is clear, but it is important to remember we are talking about where a company is headquartered and not where it does business. Most large companies today are global in their business efforts, but everyone has a home somewhere.
This tilt towards U.S.-based growth companies, most of which are technology companies, began in the aftermath of the financial crisis. The decade of the aughts was led by small value stocks and international stocks. It seems so long ago now, but this was the so-called lost decade where the S&P 500 went nowhere. While the media obsessed over “stocks” going nowhere, small company stocks and the stocks of companies headquartered overseas did very well. Then the crisis hit.
During the crisis, panic ruled and all stocks were thrown out like babies with bathwater. Then we had the knee-jerk rebound, and once that was over a new bull market took hold. However, when the global economy should have been rebounding dramatically, we instead went on a horrible detour of economic stupidity. Governments seemingly did everything in their power to keep us in the “new normal;” that was artificially low economic growth. During a period of low economic growth, investors will generally favor the stocks of companies that can grow faster than the economy.
The financial crisis started in the U.S. and thus we were the first to emerge out of the crisis. This, and our advantage in technology, gave us a head start on the rest of the world. The combination of these two factors led to the outperformance of U.S.-based technology (growth) stocks. This is how usual market cycles go. These cycles usually last five years, and this is the unusual part: We have been in this cycle for a decade.
Let me put some numbers to it. As of June 30, 2020, the Russell 1000 Growth index, which represents large U.S.-based growth stocks, is up 17.2 percent annualized. The Russell 2000 Value index, representing small value stocks, is up 7.8 percent. Companies headquartered in emerging markets, represented by the MSCI Emerging Markets index, saw their stocks go nowhere at 0.8 percent annualized. Developed international markets as represented by the MSCI EAFE index were up only 6.2 percent.
Not only has this been going on for a decade, but it has gotten worse lately. The last 12 months ending June 30 saw the Russell 1000 Growth go up 23.2 percent while the Russell 2000 Value is down 17.4 percent. This is the largest gap since the Tech bubble. That ended and this will too.
This leads us to our questions, how and when? No one knows when, but with things this extreme it would seemingly have to be soon. How is more interesting. The tech bubble burst with a long bear market. However, history doesn’t always repeat itself exactly. These companies are a lot more mature than they were 20 years ago. They may not collapse so much as go nowhere. As I write this, their CEOs are testifying to legislators who can agree on little other than the dislike of large tech.
There is really a lost decade in stocks not included in the U.S. large-growth bucket. I believe we will see a long period of reverting to the mean, and these companies will once again get to lead the way. Markets can go up being led by companies other than U.S. tech firms; it is about time for that to happen. Diversification has not really helped investors over the last decade, which leads me to believe it will be more important than ever over the next decade.
Chuck Osborne, CFA