O’ Value Where Art Thou?

It has been a rough year for value investors. However, there have been glimmers of hope, where value stocks have surged for a few days. Yet, those rallies were ultimately not sustainable and coincided with strong performance trends from heavily shorted stocks.

That lack of sustainability has left investors with a specific value bias lagging, as growth stocks have pushed broad equity measures –like the tech-heavy NASDAQ – to record highs, even with the COVID-19 pandemic weighing on the economy and society. The growth-over-value trade has been widespread as well, leading investors to ponder whether value stocks will return to favor.

Broad-based value underperformance

The trend is more alarming given that value’s underperformance is not confined by market segment or geographic region. As shown below, value has underperformed for the year to date, as well as both before and after the March 23 market low, when measured by US market cap segments (both traditional cap-weighted and pure factor drive), and when compared to international stocks.

The most pronounced outperformance is within large-cap stocks, a reflection of how mega-cap growth stocks have driven broad market performance this year. However, except for traditional large-cap style screens, the pre-market bottom differential is lower than the post-market outperformance difference. For those looking for value greenshoots, while value underperformed post-market bottom, it did so by less than it did pre-market bottom. Not really a feat to crow about, though, as the underperformance across all segments was still 5% or greater. However, the catalyst was the hope for a recovery as value historically performs well during economic recoveries.¹

Persistency of underperformance
Here is a test. Which performance example reflects a more sustainable trend and not a result of an idiosyncratic event?

• Option A: Growth beats value by 10% in one week, and matches value performance over the next three weeks in the month
• Option B: Growth beat value by 2.42% each week over the course of a month

In both cases, the monthly outperformance is 10%. But option B represents a more sustainable trajectory as performance from option A may be from a non-repeatable event. This is the frog-in-the-pan2 momentum theory, and measuring overlapping five-day periods is one way to add robustness to any performance analysis to see if the trend has persistence.

The below chart depicts the percentage of five-day periods in a given year where large-cap growth outperformed large-cap value. In 2020, growth has outperformed value in 73% of the five-day periods — the highest percentage ever. In addition, the average outperformance is 1.73%, the highest ever and 13 times greater than the historical average (+0.10%).

The below chart depicts that in 2020, both the trend and magnitude of growth over value is on another level. When breaking down the year-to-date period, we can see that for only a brief period in June was there any persistency of value beating growth — and as mentioned earlier— that coincided with high short interest stocks rallying as well.

Controlling for sector biases
Sector differences can play a role in growth versus value, and there are two ways to analyze this data.. One is to equal weight the sector allocations within the respective style exposures, and the other is to perform intra-sector performance analysis based on valuations.

The below chart shows the results, first, by taking the underlying holdings of the S&P 500® Index Pure Growth and Pure Value Indexes and equal weighting the sectors (9.09%), as well as equal weighting the stocks within the sector exposures. Even when reducing sector and stock concentration risk, growth has handedly outpaced value this year — up over 20%.

The other process to identify if sector biases play a role is to look at value and growth stock performance intra-sector. To do this, all S&P 500 stocks within their respective sector were separated out into terciles based on their price-to-book ratio. The median tercile stock performance for high price-to-book (growth oriented) and low-price-to-book (value oriented) were then calculated.

The performance differential by sector is plotted below. Prior to the market bottom, the growthier stocks outperformed the value stocks in every sector. Post market bottom it has changed, but materially only for one sector (Consumer Discretionary, consisting of beaten down airline, cruise and hotel stocks that have rallied). Year to date reflects a similar picture, and the magnitude of the performance differential is skewed towards growth, as the average positive spread (growth stocks winning) is 9% versus average -4% negative spread.

Where to next?
In our recent outlook, we discussed that “value is cheap” based on valuation spreads Further, analysis from Bank of America shows that value stocks have led the recovery in 14 out of the last 14 recessions. However, the shape and timing of the recovery remain uncertain. Stocks have risen, but economic data remains challenged. Additionally, given the health and humanitarian aspect of this crisis, this will almost definitely be unlike any recovery we have witnessed – making the fourteen out of fourteen statistic hard to lean on. Not to mention, the firms at the forefront of re-shaping a new society are from high-tech, innovative market segments.

For the rest of 2020, there will be fits and starts but growth styles are highly likely to continue their run, as broad economic and fundamental growth is still going to be challenged throughout the year as community re-openings have their own fits and starts. And in an environment devoid of growth, investors are likely to seek it out and not be too concerned about paying a premium — especially for those areas reshaping our way of life.