Robert Zuccaro, CFA is Founder and CIO Of Target QR Strategies managing the Golden Eagle Growth Strategy.

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Russell Investments makes the case in its “2021 Equities Outlook: Value’s Time to Shine?” that value stocks will outperform growth stocks for years to come. Much of their case rests on “regression to the mean” theory, given significant underperformance by value stocks relative to growth stocks over the past 15 years. The suggestion that value stocks will outperform growth stocks based on regression theory is simplistic and ignores the underlying fundamentals that favor growth stocks.

The Russell 1000 Growth ETF enjoyed a banner year in 2020 with a return of 38.2% compared to 2.7% for the Russell 1000 Value ETF. Fortunes flip-flopped in February as the Value ETF beat the Growth ETF for its best relative showing in any month since 2001, according to Bank of America. In March, Bank of America jumped on the value bandwagon saying value stocks will continue to beat growth.

The Wiesenberger Mutual Fund report traced fund performance by style each year from 1959 through 2004. It found that a $100 investment in growth funds in 1958 would have grown to $9,380 by the end of 2004. The same $100 investment in value stocks would have grown to $7,046. Hence, the growth style established a premium of 33% relative to the value style over 46 years.

Now lets consider the performance of the Russell growth and value ETFs in the past 15 years. Cumulative returns for the five-year period ending 2020 were 170% for the growth ETF versus 75% for the value ETF. Thus, there was a growth premium of 133%. Over the 10-year period ending 2020, growth returned 349% versus value’s 164%, for a premium of 113%. And over 15 years, the returns were 426% and 130%, respectively, with a premium of 228%.

Growth premiums have widened significantly in each time period relative to the Wiesenberger growth premium of 33% earned over 46 years. It should also be mentioned that growth won out in 10 of 15 years. Why then have growth stocks significantly outperformed value stocks in the past 15 years?

There has been a seismic shift in the U.S. economy that has carried over to the stock market. During the period when Wiesenberger tracked fund performance, value companies displayed sensitivity to economic cycles, which continues to this day. When the economy turned down, so did their sales and profits. When the economy turned up, so did their sales and profits. Sometimes profits would rise to record levels on the upturn.      

Until the turn of the century, the U.S. economy was heavily influenced by industrial companies before technology companies came of age. Apple went public in 1980 with an IPO of $101 million (not billion). Microsoft went public in 1986 and Amazon in 1997.

As late as 2010, there were only two technology companies among the five largest by market cap in the S&P 500. At the end of March, the five largest were all tech companies: Apple, Microsoft, Amazon, Facebook and Google. The stocks of these five companies fall into growth stock nomenclature and represent an unprecedented 22% of overall weighting of the S&P 500 as of year-end, according to my firm’s findings. Each of the big five reported record earnings in 2020 with an average gain of 36%, whereas S&P 500 earnings declined 32% compared to 2019.

I have argued and documented time and again that earnings growth is the key driver of stock prices. Many growth companies continue to report record earnings year in and year out. By comparison, earnings for many companies in the airline, banking, energy and auto companies peaked many years ago, according to my research. This can be seen in the list below that shows the peak profit year for eight companies and compares their earnings per share (EPS) that year to their EPS in 2019, the year in which overall profits rose to a record high. (Using the pandemic year of 2020 would make the comparison even worse as five of the eight companies lost money last year).

• American Airlines: 2015, -66%

• United Airlines: 2015, -41%

• Bank of America: 2006, -40%

• Citigroup: 2005, -83%

• Chevron: 2011, -89%

• Exxon: 2012, -65%

• Ford: 2011, -100%

• General Motors: 2016, -24% (This is for their new stock; after filing for bankruptcy, GM reorganized with an IPO in 2010.)

From 2015 to 2019, corporate profits rose 62% to an all-time high. However, earnings for the value companies in the above list have been in a downward trend for years. Even with improvement this year, earnings progress for each company will still fall far short of their prior peaks set many years ago. Unlike most market commentaries, which lean toward value stocks, I conclude that value stocks have gotten ahead of themselves and that their dominance may not last very long. Thus far this year, their stock prices have risen considerately more than their expected earnings improvements.

I have strong doubts that value stocks can maintain their newfound leadership in the stock market. Many growth companies, and technology companies in particular, are expected to produce record earnings in 2021 and 2022, whereas value company profits will remain depressed against prior peak levels. The chasm in profits between the two styles will continue to widen, which should work to the advantage of growth stocks. I believe the party is not over for growth stocks and that growth stocks will retake the lead in the market before the year is out.


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