There has been a spate of commentary on the recent outperformance of growth stocks, so this week we thought we would look at some of the causes of this and consider whether it may reverse.
In all big stories, the reality is often more nuanced than the headlines suggest and the growth versus value debate is no different. It is true that growth stocks have recently outperformed by a considerable degree and this had led to a degree of comparison with the tech bubble in the late nineties, as relative performance has reached these heights. Back then, the reason for growth’s outperformance was a high level of speculation in a narrow area, which had little or no earnings. The recent outperformance of the FAANG stocks does to some degree reflect a high level of revenue and earnings growth and, therefore, can be argued to be less speculative. Indeed, the FAANGs in some cases at least, have strong revenue and profits growth.
For us, the outperformance of growth is as much a factor of interest rates as anything else, and the relationship here is empirically sound.
Source: Bloomberg, 29/06/2001 – 29/08/2018.
The reason for this is that growth companies are by their very nature long duration assets: they pay little or no dividends, with returns expected in the future from rapid growth of earnings, and eventually dividends. In contrast, value assets’ returns are current, in the form of current dividends and profits. We should expect a strong relationship between growth stocks and bond yields and indeed there is, or at least there is a strong relationship between stocks with high expected growth and bond yields (please see long-term chart).
What is concerning in the chart is the post 2016 outperformance of growth, despite rising bond yields. In a period of rising yields, it is normal for value to perform well as a style but the opposite has been the case, to a very significant degree. A favoured explanation is the rise of the ETFs and indexation, with an apparent relationship between valuation and the number of indices in which a stock appears. This is clearly a factor and, given the scale of flows into passive strategies, a degree of concentration is inevitable. The ETFs prefer expensive and big stocks and this has driven the recent outperformance of growth as a style.
Another explanation, and perhaps the other side of the same coin, is the sheer scale of the tech behemoths. This makes their outperformance more painful for active managers, the best of which would not want to hold the concentrated portfolio implied by holding even an index weight in these dominant names. Now these names are so large in the benchmarks, active managers feel compelled to own them to reduce the risk of underperformance: classic bubble behaviour, fear of missing out.
If bond yields resume their push higher and earnings growth continues to be strong in the wider market outside technology, there must be a significant risk of mean reversion of growth versus value. Our portfolios, despite having material exposure to our thematic growth stocks, do have an overall bias towards value at present, partly because we weight positions by risk not considering index weights, and in that sense it has been a frustrating period. We will not be exiting our growth positions unless there is stronger evidence of that mean reversion taking hold.
Past performance is not a guide to future returns.
The value of stock market investments will fluctuate and investors may not get back the original amount invested.
Forecasts are not reliable indicators of future performance.
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Source for information: Miton as at 29/08/2018 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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