2022 was hailed a year of revival for value strategies, but they have been comprehensively outpaced by growth strategies to date in 2023. The MSCI World Growth index has beaten the MSCI World Value index by around 14% since the start of the year, with weaker commodity markets, economic weakness and the banking crisis all playing a role.
This wasn’t how it was supposed to be. A higher interest rate environment traditionally favours the value style and value still looks cheap by most historic standards. However, old habits died hard and growth has seen some revivals at various points – notably in late summer 2022 and early in 2023. There has been a lingering sense that investors would still rather be investing in technology, even if value sectors have had short term allure.
Joe Little, chief strategist at HSBC Asset Management, says: “The strength of growth stocks has propped-up markets this year, confounding economists’ forecasts.” He attributes the relative weakness of value stocks to their more cyclical profits. “They have been impacted by rising recession risk in advanced Western economies (North America, Europe, and Australia). We expect these economies to enter a recession from Q4 onwards and see weak growth/disinflation in 2024.
“As growth becomes scarcer, investors look more to growth stories. Growth stocks, with longer term cash flows, have also benefited from the market pricing in Fed rate cuts later in the year and in 2024.”
That said, the group recognises that in Asia, the opposite has been the case: “Value is outperforming growth in Asia and the emerging market indexes. The world is inter-connected, so there can’t be a complete un-coupling.
But the economic cycle in Asia is in a very different place to the West – where a ‘cyclical recovery’ story for the economy is supporting value in Asia. A rapid China reopening, a consumer services recovery, and expectations for stronger Asia GDP this year have all boosted Asia value stocks.”
However, the latest style analytics report from Confluence suggests a more nuanced picture emerged in April. It suggests neither value nor growth are now the key driver of investment returns. Instead, investors have prioritised yield and quality.
The report said of the US market: “While traditional measures of growth (like sales growth and earnings growth over the past five years) slightly underperformed this month, other aspects of growth, such as dividend growth and forecasted growth outperformed this month alongside quality.” In Europe, value remained neutral, yield and dividend growth outperformed.
Alex Lustig, senior consultant at Confluence and the report’s author, says: “There are other factors that have driven a lot of outperformance, notably yield and quality. Yield has outperformed, growth has underperformed and alongside yield, investors are focusing on safe companies with strong yields, but also have stable earnings and profit margins.”
Though again, it varies from market to market. Growth companies continued to underperform in the UK, for example, with investors clearly maintaining their defensive positioning and favouring high-quality stocks with stable earnings and sales growth, while avoiding volatility.
Dividend growth hasn’t been as important for UK investors. In Europe, it’s a slightly different picture again. The Confluence report shows mixed signals from quality, with value neutral and yield and dividend growth outperforming.
Morningstar data shows a different picture again, suggesting that value outperformed growth in April – 2.7% in Euros versus 1.8% respectively. While growth companies such as LVMH, Novo Nordisk and L’Oreal outperformed, the growth side was pushed lower by the weak performance of ASML. On the value side, Shell and TotalEnergies did well, but the weakness in the mining sector exerted a drag on returns.
What does this suggest about the possible future performance of the two styles? Lustig still sees a longer-term preference for value across all markets, even if growth has had periods of revival. His view is that the value trend is still in place, but is less pronounced: “This time around, there hasn’t been a clear value dominance as there was last year, there are shifts in the trends. Volatility is down and size is up, but it is still going in the same direction.” Certainly, the valuation gap between growth and value strategies remains at historically wide levels.
However, it appears that the trends are weakening, with value and growth becoming less informative on the likely direction of markets. While a higher interest rate environment should favour value companies, this may be because it’s historically been associated with a stronger economic environment and therefore strength in some of the cyclical companies that are part of the ‘value’ indices. Today, the economic environment is weakening, so these companies may not see the same bounce.
On the other hand, it is difficult to make a case for growth while interest rates are high. Growth companies still look highly value on most metrics. The MSCI World Value has a forward p/e of 12.3x, while that of the MSCI World Growth is 24.1x. The value index price to book is just 1.8x, but this jumps up to 5.9x for the growth index. Growth may have shown weakness in 2022, but valuations are not at attractive levels. As the Confluence study suggests, in an uncertain environment, where high interest rates collide with weaker growth, it may be other elements that will drive market direction from here. This would be welcomed by many active managers, who would prefer that the market focused on substance (the fundamentals of individual companies) over style.
