Will value catch up with growth?Contributor David Lebovitz
U.S. equity market performance has been dominated by growth stocks this year, with the Russell 3000 Growth index rising by over 25% compared to the Russell 3000 Value’s meager 8% return. This performance gap is one of the widest on record, and has led investors to question whether value stocks will recover this lost ground. Given our outlook for continued economic growth and gradually rising interest rates in 2018, we believe there is good reason to expect that value could outperform growth in the coming quarters.
Value stocks tend to outperform growth stocks when interest rates are rising. With the Federal Open Market Committee set to hike rates in December, and possibly three or four times next year, the path of least resistance for short-term interest rates is up. Furthermore, the normalization of monetary policy, coupled with a gradual reduction in the Federal Reserve’s balance sheet and continued economic growth, should lead long rates to drift higher next year. While rising rates will eventually become a headwind for equities, we are not yet at that juncture, as low and rising rates signal healthy economic growth and a modest pickup in inflation.
The risk to this view is that rates remain low on the back of a subdued macroeconomic outlook. As we have seen countless times throughout this cycle, a lackluster economic backdrop has led investors to embrace growth stocks as they search for better-than average returns. However, given the potential for the above-trend economic growth seen over the past two quarters to be sustained into next year, along with higher rates of inflation on the back of further tightening in the labor market, it seems reasonable to expect that the gap between value and growth may finally begin to close.
Rising rates tend to support value outperformance
Value/growth relative performance and 10y yield
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