After An “Amazing Run” Do High-Growth Stocks Still Deserve Your Attention?

After An “Amazing Run” Do High-Growth Stocks Still Deserve Your Attention?

over 3 years ago3 mins

For the past few years we’ve been living in a world where investors who shunned the cheapest “value” stocks in favor of “growth” stocks with fast-expanding profits have done very well. But even as growth stocks’ valuations climb to heights not seen since the dotcom bubble, new research from TS Lombard doesn’t see the trend ending anytime soon.

What does this mean?

While buying the cheapest stocks makes intuitive sense – “buy low, sell high” is, after all, a market cliche – the strategy has performed surprisingly poorly over the past 30 years or so. Meanwhile, growth – the yin to value’s yang – has been going gangbusters in 2020.

Check out their relative returns:

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The rally has driven growth stocks’ price-to-earnings (P/E) ratio to a two-decade high, while the gain in value stocks’ P/E ratio has been more subdued.

Growth stocks’ valuations are high compared to value
Growth stocks’ valuations are high compared to value

“Following an amazing run that has propelled the multiples of technology companies into the stratosphere, many investors are now wondering whether the time has come to lighten up one’s exposure to this sector and start looking around for bargains,” TS Lombard wrote in a report over the weekend. “Look a bit closely, however, and the argument for rotating intovalue appears less convincing.”

Why should I care?

Timing rotations between different parts of the stock market is incredibly hard – and many investors who try fail miserably. So TS Lombard is understandably reluctant to give a definitive call on where growth and value will go from here. But they do point to a couple of factors in favor of the growth rally continuing: Federal Reserve support that’s encouraging risk-taking behavior and relative valuations that are still well below the peak of the dotcom bubble.

If you’re convinced that growth stocks’ gains will imminently stall, however, and insist on tilting your investments toward value, TS Lombard recommends shunning the largest value stocks in favor of smaller ones.

“In the past 30 years, value investing has worked only in small caps,” they write. “Investors looking to rotate from growth to value would be better off doing so in small caps, where the odds of a sustained period of value outperformance are more favourable. However, they should bear in mind that if a financial bubble is indeed brewing, it may continue to do so for longer than many expect. Under such a scenario, growth will probably keep doing better until the bubble pops.”

Meanwhile, although TS Lombard may see few reasons to buy value stocks, especially the bigger ones, a separate report this month from the French investment bank Societe Generale gives some succour to fans of value.

SocGen argues that buying value stocks is a good way to protect against rising bond yields – if, for example, inflation started taking off. As the chart below shows, value is one of the few so-called factors to show a negative correlation with bond yields, meaning their prices rise when bond prices fall (and bond yields rise).

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“Value is important for diversifying valuation risk across all the other factors, which are not only extremely expensive, but also equally at risk from higher bond yields,” according to SocGen. If inflation flares up and bond yields rise, value stocks might be there to help cushion the fall “when market valuations implode under their own weight.”

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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