Growth Vs Value Investing: A Barbell Approach

During different stages of an economic cycle, markets can reward certain assets while hurting others.

Early in a cycle (after a recession) the growth tide lifts all boats. While more growthy companies were en vogue when growth was harder to come by, formerly unloved companies may become relatively more attractive at this stage. When numerous market participants simultaneously decide that this type of economic shift is underway, this will typically result in a rotation.

To better understand the effects of a rotation, a quick refresher on growth vs value investing is instructive. “A crucial difference between the camps is the length of time before you might expect to make your money back — value investors do so more quickly by virtue of buying businesses in which the wider market has low expectations.

For example, if you were to spend $100 buying into a value business on a price/earnings (P/E) ratio of 5x, say, that multiple suggests your shares should make $20 a year in profits, and so you would make your money back after five years. In contrast, a growth business is likely to have a high P/E ratio, which means low profits today, but growth investors allocate in the hope of making their money in, say, years 16 to 20 rather than the first five.

In financial-speak, that makes the value business a ‘short-duration’ asset and the growth business a ‘long-duration’ one.

Before we even had a vaccine, there were calls for a rotation from growth to value, with Goldman Sachs strategist Peter Oppenheimer noting a “sharp rotation of leadership towards value” due to the reopening of economies worldwide.

Calls for a rotation only got louder after positive news concerning vaccines came out.

JPMorgan’s renowned quant analyst Marko Kolanovic concluded that an effective vaccine should mean that long-underperforming value stocks would finally have their moment.

"The backdrop of globally synchronized expansion, legislative gridlock and positive vaccine news should mark a breakout point for value stocks, which have been beaten down due to the COVID crisis... By contrast, momentum/growth stocks should lag."

News that the Pfizer vaccine could be at least 90% effective in treating the coronavirus sent value stocks soaring the day of the announcement, with the iShares Russell 1000 Value ETF jumping over 6% on November 9th, 2020 before ending the day up over 4%.

Per Reuters, “The research in Israel - two months into one of the world’s fastest rollouts, providing a rich source of data - showed two doses of the Pfizer shot cut symptomatic COVID-19 cases by 94% across all age groups, and severe illnesses by nearly as much.”

Now Johnson & Johnson’s latest vaccine has been approved and may continue this narrative.

At the time of the original Pfizer announcement, JPMorgan advocated a "barbell" strategy and warned investors to balance their portfolios, so they are not overexposed to growth stocks or underexposed to value stocks.

A “barbell” approach is when investors weigh a portfolio roughly half and half between two different factors instead of concentrating on one factor or diversifying among many different factors.

"Recent developments should help revitalize the value trade and give it greater staying power," JPMorgan said. "In a rising market, momentum likely lags, but given superior fundamentals it should not see an outright crash. In other words, we see value converging to the upside as opposed to momentum converging to the downside."

Analysis of returns via Societe Generale SA demonstrates that, though many investors have bought the most volatile value stocks in 2021, they have also been buying riskier growth companies as well.

“The demand so far this year has really been for the riskier stocks, be they expensive and exciting technology names or cheaper names beaten up by the economic slump,” wrote strategists, including Andrew Lapthorne.

Barbell Brigade

Investors chasing cohorts of both value and growth stocks this year

Bloomberg continues, “Late last year, hopes for further stimulus after the U.S. election and the start of vaccination campaigns sparked a global rotation into value sectors out of more favored industries like technology. While all the elements for that value beat remain in place — improving growth and inflation expectations — this data suggests investors have adopted a so-called barbell strategy and are refusing to give up on the growth names that have worked so well.”

“The story of the last few months has been less about value versus growth and more about a rally in riskier stocks” the SocGen strategists wrote.

JP Morgan and SocGen are both advocating for a barbell approach.

SocGen’s view that inflation should benefit value investing is shared among the broader finance industry.

As pointed out above by Schroders, value stocks reunite investors with their money quicker than growth stocks do and, “in an inflationary environment, money now is worth more than money further down the line. The further into the future the money is, the less it is worth. It is for this reason that value, which sees investors recoup their money sooner rather than later, is more attractive in an inflationary world.”

Seeing as how multiple strategists are calling for a rotation, perhaps it is helpful to look back at a historical example of how the broader markets fared in the past.

In December 2001, CNN declared, “Small (value) is beautiful. In a rough year, small value stocks have delivered.”

Dimensional Fund Advisors warned “Some of the weakest periods for value stocks when compared to growth stocks have been followed by some of the strongest… On March 31, 2000, growth stocks had outperformed value stocks in the US over the prior year, prior five years, prior 10 years, and prior 15 years. As of March 31, 2001 — one year and one market swing later — value stocks had regained the advantage over every one of those periods.”

But calls for a rotation are nothing new. In September, 2019 MarketWatch wrote, “As the “Great Rotation” grips the U.S. stock market, more investors are turning to “value” stocks, or those that are considered comparatively underpriced or overlooked.”

And while 2020 saw a large uniform drawdown early in the year, growth stocks dominated as consumers and businesses leveraged new technology and sent growth stocks soaring. “For the six-month period ended Aug. 11, 2020, the S&P 500 Information Technology Sector index value was up 10.8% while the S&P 500 overall was down 0.7%” according to S&P Global.

Even more pronounced, “some of the S&P 500's biggest technology company stocks by market cap — Facebook Inc., Amazon.com Inc., Apple Inc., Microsoft Corporation and Google parent, Alphabet Inc. — as of July 24, 2020 had markedly outperformed the rest of the index for the year. The FAAMG stocks were up 29.2%, compared to less than 0.3% for the rest of the S&P 500.”

Sarah Hindlian-Bowler, a senior software analyst at financial services company Macquarie Group Ltd, said at the time, “There has definitely been a dollar rotation into technology in this current environment.”

As mentioned earlier by SocGen, that trend has changed with value performing well since the election. Whether a rotation is in full swing or the markets are experiencing a head fake before the familiar leaders take charge again remains to be seen.

Compounding the difficulty, UBS has called for growth to outperform value as monetary policy goes from easy to neutral and inflation fears peak.

Real Deal
Inflation-adjusted yields have lurched higher this month

Bloomberg frames this call for growth to outperform as a rotation itself. This is despite the fact that value’s recent run is nowhere near the magnitude of 2000’s shift and that tech’s outperformance over the summer was termed a rotation.

Clearly, rotating is neither a simple exercise nor a predictable event. But missing a rotation from growth to value investing can crush returns. At the same time, investors are wary of dumping growth stocks that have suited them well over the past economic cycle.

Instead of taking an all-or-nothing approach to growth vs. value investing, a barbell approach, which gives investors exposure to both growth AND value is appropriate.

Perhaps that’s why multiple strategists are calling for a barbell approach instead of advocating for a wholesale shift of one’s portfolio of assets.