Question of the Month
This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.
Is it time to switch from growth to value?
This question keeps coming up in one from or another. Perhaps the more direct question is, are we in a bubble territory and is it perhaps time to reduce risk? Of course, it’s always easy to explain the past, but everyone would like to know what tomorrow brings. Naturally, the answer, as with most things in life, is: it depends. And the key factor it depends on is your time horizon. Let me explain.
Growth stocks tend to rely on organic growth due to increasing market opportunities. Value stocks are traditionally defined as more steady and mature businesses, with predictable cash flows, typically paying dividends and trading at low valuation multiples. Historically, value and growth styles trade places for periods of business cycles. Usually, when economy goes through an expansion, growth is in favor, while value doesn’t move up as much. In periods of slow growth and especially recession, however, growth stocks may suffer significantly more than value stocks. The value and growth styles are thus often treated as broad approximation of risky vs. conservative investments.
The chart below uses the most common Growth and Value ETFs (IVV and IVW, respectively) to show relative performance over the past 20 years. The value has outperformed in slow growth and recession times (2004-09) but underperformed the rest of the time. In fact, the growth style has outperformed significantly over for the past 5 years and especially in the last nine months of 2020.
On one hand, that amplified the calls for reversion to the mean. On the other, it has underscored the difference this time around. Who is right?
The argument I’d like to make is that things are different now. We no longer find ourselves in just ordinary times. We are in fact in the midst of an industrial revolution. To take a quick history detour, there are three distinct industrial revolutions occurring in the Western society in the past 250 years or so and they all have these common properties:
Science and technology led to new manufacturing paradigms
New energy sources emerged
New transportation and communication services were introduced
All of the above led to significant improvements in quality of life
The first Industrial Revolution started in England in 18th century and was characterized by new manufacturing processes based on chemicals and iron production processes, supported by steam and water power. They led to the rise of mechanized factories and eventual unprecedented urban population growth. The Second Industrial Revolution, also known as the Technological Revolution, that started around 1870, saw the manufacturing innovations that established the machine tool industry and led to the assembly line, aided by the rise of electrical power. Railroads, automobiles and planes have revolutionized transportation, while the telegraph, radio and telephone changed communications forever. The Third Industrial Revolution (also known as the Digital Revolution) has begun in the second half of the 20th century. It was precipitated by the invention of transistor and development of semiconductors to produce digital devices and communications, that led to personal computers and the Internet. At the same time, the new energy source of nuclear power has allowed for another leap in manufacturing and urban development.
The case is to be made that we’re on the brink of the Fourth Industrial Revolution. Breakthroughs in fields such as artificial intelligence, robotics, the Internet of Things, autonomous vehicles, 3-D printing, nanotechnology, biotechnology, materials science, energy storage, quantum computing, satellite communication, and commercial space travel cover all the necessary preconditions described above and lead to a potential explosion of new products and services to benefit humanity. It is the sheer scope, exponential speed and global impact of these breakthroughs that makes this coming surge so astounding. And, perhaps paradoxically, the pandemic has accelerated many of these breakthroughs.
In conclusion, it’s true that over the past few decades the growth and value styles have competed for investors’ attention and each outperformed for a period of time. However, during the times of unparalleled growth such as the Industrial Revolution, growth trumps value over any significant period of time, except the very short time horizons. We believe that some of the themes above and others likely to emerge will lead long-term investors to significant market outperformance, painful but short-lived pullbacks notwithstanding.