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Trading Lesson: Growth vs. Value. Is It Value's Time to Shine?

10/18/2018 1:12 pm EST

Focus: ETFS

Lindsey Bell

CFRA Investment Strategist, CFRA, Equity and Fund Research

The growth vs. value debate has again re-emerged as the pendulum has swung in the direction of value with health care, energy and industrials sectors outperforming in September. Here are four ETFs with favorable CFRA ratings: SPYG, SPYV, RPG, RPV, writes Lindsey Bell.

ETF fund flows echo this sentiment with a step up in net inflows into value ETFs in the third quarter from subdued levels in the first half of the year.

The rotation into value and out of growth has occurred a few other times this year (in three different months prior to October). It is normal for a back and forth between these two styles of investing in any given year.

This time around the rotation may be receiving heightened attention given the impressive multi-year run in growth, with questions of its sustainability. The valuation differential between growth and value also has some considering that it might be value’s time to shine.  

After a stellar August for the growth half of the S&P 500 (SPX) equation, the margin of outperformance by the S&P 500 Growth Index narrowed to 0.4% points in September vs. 3.7% points in August. In October, both styles of investing moved sharply lower amid the market turmoil, but investors sold less value than growth.

The Value Index is 2.7% lower through October 17, while the Growth Index is 4.3% lower. If the trend continues, this will be the fourth month for value to outperform growth in 2018. Historical monthly performance shows a rotation between growth and value occurring 6 times a year on average going back to 1975. In other words, each style outperforms 50% of the time on a monthly basis. 

Entering 2018, several investors and strategists thought a backdrop of fiscal stimulus, tax reform and other pro-growth policies, in addition to rising interest rates, would boost value indices. Yet on a year-to-date basis, growth is 11.1% higher, while value is 1.2% lower.

Investors have stuck with growth as earnings expectations for 2018 moved higher at a faster rate than the earnings expectations for value. Now as investors weigh how to position for 2019, the economic picture remains solid, but uncertainty surrounds trade, foreign policy, rising interest rates and earnings growth. 

Earnings growth for both indices are expected to decline to about 10% in 2019, from greater than 20% in 2018. The year-over-year reductions are in-line with what is expected from the S&P 500: 2019 EPS growth of 9.9% vs 21.9% in 2018.

Growth may have a bit of an edge as the bar for 2019 earnings growth has been lowered since the end of June, with estimates declining to 10.3% from 11.1% previously.

Pure Growth has experienced an even bigger decline, with 2019 earnings growth expectations reduced from 11.4% in June to 8.1% currently. Value expectations instead have moved slightly higher over the same period, with the current estimate pegged at 9.7%, up from 9.3%.

Valuation favors value indices, and that has been the case for the past two years. The discount by which value trades has admittedly gotten wider over that period. Historically, the S&P 500 Value Index price-to-earnings ratio (P/E) has traded below the S&P 500 P/E, but the discount on a historical relative basis has increased to 9%, from 5% at the start of 2018. 

The relative valuation for the Value Index is at the lowest level since at least 2005. From 2003 through 2006, when value outperformed growth, the Value Index traded at a much higher relative multiple of between 0.90x to 0.95x (today it is at 0.84x). 

Growth, on the other hand, has historically carried a premium to the market, but current multiples are higher than the historical average, even with the recent pullback. Growth trades at a 9% premium to its historic relative valuation. Pure Growth’s relative valuation is now at an 5% premium to its historical average, which is below the 8% premium it carried in June but is up from a 1% premium in January. 

chart 1

As we enter the later stages of this business cycle, investors want to know if the latest rotation into value is here to stay. As it currently stands, earnings growth prospects remain in favor of the growth indices, with estimates reduced and still higher than value. Valuation, however, remains in favor of the value indices. To square it all, we look at historical price performance in both a mid-term election year and surrounding bear markets.   

Historically the overall market performs very well in the 12 months following a midterm election, rising an average of 15.1% since 1978. Growth usually leads the way, increasing 18.2% on average in the 12 months following the election. That compares to the 12.5% return in the Value Index in the same period, with value only outperforming growth in 3 of the 10 instances analyzed. What’s more, Pure Growth outperforms Pure Value by a margin of 16.1% points and outperforms Growth by 6.1% points.

chart 2

Despite the widely-held belief that value beats growth, the S&P 500 Growth Index has recorded a greater frequency of beating the S&P 500 than has the Value group, based on price returns six months before, during and after bear markets and corrections since 1980, according to CFRA’s Chief Investment Strategist Sam Stovall.

Despite the valuation differential, the price performance history remains in favor of growth and this year has proved that in times of uncertainty, investors have returned to what they can rely on – and that has been growth. 

Regardless of which style you believe will be the winner in the next 6-12 months, CFRA has research on several ETFs that will fit your needs.

SPDR S&P 500 Growth ETF (SPYG) and SPDR S&P 500 Value ETF (SPYV) are the lowest cost ETFs that track the S&P 500 Growth and Value indices. Both ETFs charge a miniscule 0.04% net expense ratio, less than offerings from iShares and Vanguard, contributing favorably to the CFRA rating.

For investors who favor the pure style index approaches, Invesco S&P 500 Pure Growth (RPG) and Invesco S&P 500 Pure Value (RPV) each charge a 0.35% expense ratio.

View CFRA, services and research including Marketscope Advisor here.

View brief video interviews with Lindsey Bell of CFRA:

Lindsey Bell’s picks: Apple, AI, Nvidia, Intel, semiconductors here.
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Q2, Q3, the worst. Q4 good news here.
Duration: 3:53
Recorded: MoneyShow Las Vegas, May 15, 2018.

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