Welcome to RBC’s Markets in Motion podcast, recorded March 26th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
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We’ve been spending a lot of time with investors discussing Growth vs. Value. The shift in leadership in the stock market back to Value that’s occurred in recent months has been painful for many institutional investors, and most are hoping that it will be a short term trade rather than a more lasting transition.
Our take: we see more room for Value to outperform, and are sticking with our call for Value leadership in 2021. We think whether Value continues to lead beyond this year is still open for debate – and depends on whether the economy can sustain above trend GDP growth in 2022 and beyond.
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Value has strongly outperformed Growth within the Russell 1000 since September. This latest round of Value leadership has been much more consistent and durable than the numerous head fakes that occurred in late 2019 and the first half of 2020. Most buy-siders aren’t convinced Value leadership will last, but it’s become consensus in the macro forecasting community to say that it will, for a little while longer at least.
Though we don’t like being part of the sell-side consensus, our conviction level is high. We prefer Value over Growth for 2021 for a number reasons: Flip to slide 4
- First, Value looks better from a cash deployment angle. Value has more dividend appeal than Growth. Value has also seen a bigger recovery in buyback announcements than Growth so far. Flip to slide 5
- Second, earnings revisions momentum no longer strongly favors Growth, reversing an important pillar of support for the Growth trade in recent years. In recent updates, our main gauge of earnings sentiment (the percent of sell-side EPS estimate revisions to the upside) has slightly favored Value over Growth, unlike what we saw in 2017 through most of 2020 when earnings revisions trends strongly favored Growth. The last time this happened was 2016, when higher interest rate expectations supported higher revisions in Financials, which boosted Value revisions. Flip to slide 6
- Third, futures positioning data from CFTC suggests that Nasdaq has had a bit more of a positioning problem than other parts of the market. Over the past few weeks, Nasdaq futures positioning has been retreating from levels that had returned to past peaks on both the dollar value of positioning, and the number of contracts owned. Byt contrast, S&P 500 and Russell 2000 futures positioning has been extreme on a dollar value basis, but not the number of contracts owned and recent slippage has been mild on those contracts in comparison to Nasdaq. Flip to slide 7.
- Fourth, valuation. Despite the underperformance it’s seen since last Fall, Growth continues to look significantly overvalued relative to Value—we see that on both our multi factor model and a simple forward P/E comparison. Flip to slide 8.
- Fifth, recent history suggests that Value is likely to outperform as long as the reflation and economic recovery narrative remains intact. Trends in Value/Growth relative performance has been mostly aligned with trends in the yield curve since the Financial Crisis. We expect Value to continue to benefit from improving investor optimism on vaccines and the broader economic recovery story. Flip to slide 9.
- Finally, ETF flows have been surging for Value. While they’ve turned positive in Growth again, they aren’t nearly as strong as Value. This reveals a willingness to embrace the Value trade in a way that hasn’t been seen in quite some time. We are seeing similar shifts in flows back towards previously out of favor categories such as Small Cap, Mid Cap, Energy, and Financials as well.
These are all intermediate term reasons to prefer Value to Growth.
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- We have viewed the question about whether Value can continue to outperform Growth longer-term as worthy of healthy debate.
- Historically, sticky leadership shifts at the style level have occurred around recessions. Value started working in the aftermath of the Tech bubble, and held on to that leadership until shortly before the Financial Crisis when Growth took over again in a trade that lasted well beyond a decade. Flip to slide 11.
- But history isn’t enough. The Value trade’s ability to seize this opportunity and retain leadership beyond 2021 is dependent on the ability of the US economy to sustain above trend growth in 2022 and beyond.
- US quarterly GDP growth has been, on average, 2.5% yr/yr since 1979. Value has usually outperformed Growth when actual GDP has been above this long term average, but not when GDP has been below average.
- In other words, Growth stocks tend to outperform when growth is scarce, but Value tends to outperform when growth is plentiful.
- The good news for the Value trade is that current forecasts in the economics community anticipate above trend GDP through the end of 2022.
- The key things to monitor are 1) whether those forecasts change, and 2) how long above-average GDP growth ultimately lasts.
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That’s all for now. Thanks for listening. Please reach out to your RBC representative with any questions.