Is the ‘great rotation’ almost upon us?
Stock markets have been fairly quiet in recent days, with steady increases across the board. But take a closer look and you will see that there has been a spectacular rotation. As the graph shows, value stocks – which have lagged growth stocks for almost 15 years – seem to be catching up. Is this a signal that the ‘great rotation’ is on its way?
Despite having underperformed in the past decade and a half, value stocks have outperformed growth stocks since 1975. A key explanation for this long-term trend is that investors tend to be overly negative about dull, slow-growing value stocks – typical characteristics of value stocks – and are generally much more enthusiastic about growth stocks, which seem to offer limitless potential.
This extrapolation of future expectations has to be adjusted at some stage, at which point value will once more outperform growth. But the fact that this has not happened in 15 years suggests that more factors are now at play, with the increasing scarcity of growth being one example: global growth had slowed in the run-up to the financial crisis and waned further once the crisis had erupted.
This could mean that investors are willing to pay more for companies that show high growth. In addition, secular trends are almost certainly playing a role. The past two decades have been characterized by enormous technological breakthroughs. From advanced production processes to a shift towards online consumption, and the emergence of social networks such as Facebook: they are all driven by technology.
And technology companies are, as a rule, growth companies. On the other hand, one of the more traditional value sectors – banking – is struggling. The aftermath of the financial crisis, increased regulation and new competition in the form of fast-growing fintech companies have put this sector under considerable pressure.
It is difficult to say whether the rotation will continue. Investors certainly will continue their habit of extrapolating expectations. This could justify a tilt towards value stocks. What is more, value stocks are currently cheap from an historical perspective. In other words, they are inexpensive relative even to their own long-term valuation.
And when economic growth picks up, partly as a result of new central bank stimulus, growth will become slightly less scarce. But this doesn’t mean it there’s no case for owning growth stocks. Companies that specifically benefit from secular trends such as technological change, an ageing population, and the environment and society, could definitely outperform the market.
The key, of course, is in selecting those companies that can meet these expectations.
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