What the growth and value stocks debate reveals about the future of the bull market
Does the resurgence of value stocks versus growth stocks mean that the days of the bull market are numbered?
I’m referring to the epic battle between two major stock styles: growth stocks (those of the fastest growing companies that trade for higher valuations) and value stocks (the companies that don’t have the favor that trade for lower valuations).
While mid-value stocks over the past century have drastically beaten growth, they have undergone significant periods in which growth has taken over. The last decade has been one of those times.
The tide began to turn in the fall of 2020 in favor of value, causing widespread celebration among value managers that maybe – just maybe – their long period of suffering was coming to an end. Most of the other managers looked on with puzzled attachment, seeing the growth versus value debate as little more than intramural rivalry.
Some observers think this attitude is shortsighted. They believe that the fortunes of growth stocks versus value stocks can tell us whether or not we are in a healthy bull market.
At first glance, their argument makes sense. Growth stocks are likely to experience the fastest growth when the economy is in full swing. And economic growth is certainly conducive to a bull market on Wall Street. So it stands to reason that a leadership shift towards value from growth could mean an impending market downturn.
This theoretical argument is consistent with the stock market experience before and after the dot-com bubble burst in 2000. The bull market years of the 1990s were one of the longest periods of the last century when stocks grew. have exceeded the value. After the bubble burst, value stocks entered one of the longest stretches of the last century when they outpaced growth.
There are exceptions in the historical record. During the Great Financial Crisis, for example, growth stocks generally outperformed value. Yet the economy contracted considerably and the stock market collapsed.
What the data tells us
To better understand this confusing relationship between market health and the relative returns of growth and value stocks, I analyzed stock market trends up to mid-1926, using data from Dartmouth Professor Ken French and Robert Shiller, professor at Yale University. For each month, I got data on value-to-growth performance, as well as the inflation-adjusted and dividend-adjusted performance of the S&P 500.
I looked for correlations between the two and came back empty. There have been times when the relative strength of value was associated with lower stock returns, and others where it was correlated with higher returns. There was no consistent model.
This is illustrated in the graphic above. It divides the data into two groups of equal size – the first covering the period 1926-1973 and the second covering the period 1974 to present. In the first half of the sample, the stock market performed best when growth beat value. It was just the other way around in the second half of the sample.
My hunch as to why there is an inconsistent correlation between the market and the relative strength of value versus growth: There is more than one reason why growth can slip behind value. The strength of the economy is only one reason. Another, which has become particularly relevant in recent decades, is a bubble in the valuation of growth stocks. If such a bubble deflates, growth stocks can lag seriously behind value stocks, even as the overall economy continues to grow.
We saw some of this during the dot-com bubble deflation between March 2000 and October 2002. Although this bear market lasted two and a half years, the associated recession only lasted eight months (from March to November 2001, according to the National Bureau of Economic Research, the semi-official arbiter of the onset and end of recessions). By the end of this bear market, US gross domestic product (GDP) was 10% above its initial level. Still the S&P 500 was down 49.1%. Much of this difference can be attributed to the return to earth of growth stock valuations.
Value stocks have done quite well during this bear market, in relative terms. Additionally, according to French data, mid to small cap stocks actually gained money during this bear market.
The bottom line? Relax. While a lot depends on whether the value style has entered a period of several years of superior growth, the fate of the bull market is not one of them.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment bulletins that pay a fixed fee to be audited. He can be contacted at [email protected]