A Tipping Point for Growth Investing
08/07/2007 12:00 am EST
Joseph V. Battipaglia, chief investment officer of Ryan, Beck & Co., who spoke at the recent San Francisco Money Show, believes the long outperformance of value stocks is ending and growth stocks will set the pace.
The current seven-year cycle favoring value stocks over growth stocks has been unusually long and has generated significant excess returns. We now believe that the intensifying downturn in housing, spreading credit risk, sharply-falling rates of household borrowing, and the potential for peak commodity prices may mark a "tipping point" for style investing.
Given the lagging performance by growth in recent years and ongoing fundamental improvements in earnings, we view the growth segments of the US equity market as more appealing with less risk than the value segments of the markets.
Therefore, we are changing our recommended tactical asset allocation mix to 65% growth stocks (from 55% previously) and 35% value (from 45% previously) for the US equity portion of portfolios.
We see the leading growth sectors, such as technology, telecommunication, media, consumer services, and health care to be well positioned for an improvement in relative performance. Core inflation measures appear to be improving, which supports the value placed upon future earnings streams. Balance sheets are generally strong for growth companies with relatively little leverage and earnings growth rates that are modest but rising. Lastly, we see the valuations for major growth indices like the S&P/Citigroup Growth index, for example, to be more attractive than similar value indices.
By sector, we note that growth is heavily influenced by technology (23%), health care (16%), and consumer services (13%). Collectively, we believe the growth sectors are well positioned to benefit from the long-run secular trends of investment in new productivity-enhancing technologies; the replacement of an aging technology base, and increased demand for health-related and consumer services.
We believe that market trends run in cycles. The chart below (reproduced with permission of Ryan, Beck & Co.) shows the relative performance of the Russell 3000 Growth index compared to the Russell 3000 Value index. (The indices include both price appreciation and dividends.)
Two things are striking about this index. First, it appears that value investing has outperformed growth investing over the past couple of decades. It is also apparent that, in the intermediate term, valuations tend to go to extremes before reverting to a more balanced level. Just as growth went to an extreme in 1999, the value indices are at a similar extreme today. At 7.2 years, the current [value] cycle represents the longest on record. Cumulatively, value stocks have outperformed value by 167% from the top of the last growth cycle, which ended in March 2000. The table below (reproduced with permission of Ryan, Beck & Co.) illustrates the duration and magnitude of past cycles.
Since growth has now hit an extreme low point relative to value, we think that markets will likely begin to look at growth in a new light. While it is difficult to predict precise tops and bottoms, we believe that now is a good time to reallocate some funds into growth at the expense of value.
At 7.2 years, the current cycle represents the longest cycle on record. While the growth-led bull market of the 1990's was fast, the current cycle has been long. Cumulatively, value stocks have outperformed value by 167% from the top of the last growth cycle that ended in March 2000.