Punchline: It's very hard to know
The ongoing debate between growth and value investing ultimately leaves us with more questions than answers. Can we accurately time the market to favor certain factors? Possibly, but it's a challenge best tackled by professionals wielding powerful computers. The key takeaway, however, is the irreplaceable value of resilience—maintaining your investment course even in the face of market downturns.
Introduction: Equity Markets in Transition
Equity markets were up huge in 2023, led mainly by tech stock (SPY and QQQ both have more than 30% of their index in 7 stocks) . This coming after a very disappointing 2022, especially for devotees of the traditional “60/40” portfolio. So there is ongoing discussion and debate about which styles and strategies are most appropriate going forward. And as we’ve been discussing, there is an ongoing explosion in thematic and otherwise active ETFs
But one of the most evergreen conversations relates to the Growth vs Value factor tilt.
The Growth vs. Value Conundrum
The choice between growth and value investing remains a pivotal, yet elusive, decision for investors. While the long-term significance of this choice may be debatable, exploring these factors offers both educational value and potential tactical advantages. Engaging computers for timing and weighting adjustments could offer a sophisticated edge, though the paramount strategy remains steadfast participation in the market, especially through volatility.
Shifting Market Dynamics
Many may not realize that the roughly 40 year period between 1985 and 2024 shows overall very similar results for Value vs Growth.
That said, between 2007 and 2020, growth stocks, exemplified by tech giants, overshadowed their value counterparts, challenging traditional valuation metrics.The spread in price to book between growth and value stocks, using Russell Growth and Russell Value indexes as indicators, skyrocketed from 4:1 in 2007 to 13:1 by 2020, surpassing even the 10:1 peak during the 1999 internet bubble. This suggests an even more intensified tech bubble scenario, especially since the relative performance of Russell Value decreased significantly compared to Russell Growth.The recent growth boom has been largely attributed to the burgeoning and booming artificial intelligence (AI) sector. This narrative mirrors the internet boom of 2000, where the internet was hailed as an all-encompassing business catalyst. Today, bets are high on AI to replicate this pattern of revolution.
Despite this, there were certain bright spots for growth - for instance, an unexpected improvement in the underlying fundamentals relative to growth. The 'migration effect', a phenomenon where value stocks get replaced with deeper value stocks, led to a faster rise in the dividend stream of a Russell Value portfolio from 2007-2022 than that of a Russell Growth portfolio.
Beyond Cap-Weighted Indexes
The RAFI methodology pioneered by Research Affiliates presents a compelling alternative to traditional cap-weighted indexes, which often emphasize momentum and growth, potentially at the expense of a comprehensive view of the market's economic fundamentals. By focusing on a company's economic footprint, the RAFI approach introduces a dynamic balance, allowing portfolios to adapt between growth and value orientations based on the prevailing market conditions. This strategy reflects a nuanced understanding of market dynamics, prioritizing economic substance over market sentiment.
Enhancing Investment Strategies
The differentiation between RAFI and cap-weighted indexes underlines the importance of evolving valuation techniques.Composite measurements such as price to sales, price to cash flow, price to book, and price to dividends plus buybacks can lend a more accurate assessment of a company's value.This approach, especially when incorporating intangibles like R&D investment, paves the way for more informed and strategic investment decisions.
Conclusion: Embracing a Holistic Perspective
The ongoing debate between growth and value investing, enriched by the insights from RAFI's methodology, underscores the complexity of today's market environment. As investors navigate this terrain, the emphasis shifts towards a more comprehensive analysis of market trends and investment strategies. The journey through these market dynamics is not just about financial returns but also about the continuous evolution of investment philosophy and practice.