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Why have value stocks been so out of favor?

Tim Gaumer
Tim Gaumer
Director of Innovation and Fundamental Research
Tajinder Dhillon
Tajinder Dhillon
Senior Research Analyst, Refinitiv

Recent years have seen growth stocks outperform value stocks. What are the reasons behind the erosion of the theory that over time value stocks will reward investors more than growth stocks? And what factors could be the trigger for a shift back towards value and smaller company stocks?

  1. Has the traditional difference between value and growth stocks been eroded?
  2. The theory followed that, over time, value stocks outperform growth stocks. The higher returns were gained in exchange for taking additional investment risks.
  3. The difference in returns between growth and value is now even higher than at the peak of the dot-com bubble.

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You might not be blamed for claiming everything we learned from the academic literature is obsolete and that traditional factors no longer work.

The theory was that, over time, small stocks outperform large-cap stocks, and value stocks, defined as those with a low price/book ratio, outperform expensive stocks — the category typically referred to as growth.

A common explanation is that the market should reward investors with higher returns in exchange for the additional risk they take in holding volatile, small-cap and out-of-favor securities.

U.S. Election Chart of the Week — Is Value Dead?

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The outperformance of growth vs. value indices

The difference in returns between growth and value is now, as seen in Figure 1, even higher than at the peak of the dot-com bubble — an observation we find rather disturbing.

Add to that the fact that some of the top performers in both the Russell 1000 Growth Index and the overall market have been among the largest companies in the world (see Figure 2) and the traditional financial theory favoring small-caps and value stocks becomes even less convincing.

Figure 1

Growth stocks vs value stocks

Is a new trend emerging out of this investment cycle?

So, is financial theory a fluke of history or, if not, what might change this strong trend of the last few years?

Perhaps it will be the election cycle.

Regardless of who wins, the market tends to be strong in the months after an election — perhaps because politicians may view it as a mandate to spend on their policy issues and campaign promises.

That spending tends to be an economic stimulus. An exception to the outperformance in an election year was in Barack Obama’s first term, after he inherited the global financial crisis. A rotation to smaller, cheaper and more economically cyclical stocks may be even more likely if the Democrats take both the White House and Senate, because a larger stimulus package and higher fiscal and infrastructure spending may result.

The calendar also plays a role during most year-end months.

The so-called ‘Santa Claus rally’ is sometimes attributed to the end of the ‘window dressing’ and tax-loss selling that funds may do. This year, the losses have been more pronounced among value stocks. That opportunity ends at the last trading day of October. You can examine these election cycle and calendar relationships in Figure 2.

Figure 2: S&P 500 Value Index — Monthly Returns since 2000

S&P 500 Value Index – Monthly Returns since 2000
Source: Refinitiv Datastream

Why the shift to value stocks?

Another election-year outcome that might trigger a shift towards value and smaller company stocks may be more regulation and enforcement actions aimed at some of the largest tech stocks and top market outperformers.

Those leaders, until recently called FAANGs, have morphed a bit into FAAMG — Facebook, Amazon, Apple, Microsoft and Google (Alphabet). Their impressive outperformance, relative to the S&P 500, even during just the year-to-date period, is shown in Figure 3.

Media reports note that there have been calls to further regulate, or even break up, companies within this collection of market leaders. Some view their size and market dominance as anti-competitive. These calls seem loudest from the EU, which is even exploring a ‘digital tax.’

Figure 3FAAMG Performance vs. S&P 500; Year-to-date. Why are value stocks out of favor?

The future for value stocks

Will this scenario come to pass? It’s very difficult to say. We assume a lot of value fund managers hope so — and soon. For the most part, they’ve been in a world of hurt.

Assets under management have dwindled, and we’ve seen at least one large and previously successful value-focused hedge fund throw in the towel. That alone, may be an indicator. Recall that Julian Robertson shut down Tiger Management in March 2000, citing losses in value stocks. March 2000 was, of course, the peak of the tech bubble. Value stocks outperformed for the decade that followed.

U.S. Election Chart of the Week — Is Value Dead?

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