By Chuck Mikolajczak
NEW YORK (Reuters) - A return to fashion of growth stocks in 2019 helped lead the overall market out of a year-end shakeout, but another multi-year run of growth performing better than value may not be in the cards.
The S&P 500 has rallied nearly 18 percent since its Dec. 24 low. During that time the Russell 1000 Growth index has fared even better with a gain of almost 20 percent while the Russell 1000 Value index has lagged with a gain of about 17 percent.
That marks a reversal from the fourth quarter, when value outperformed as stocks nearly tumbled into bear market territory, a trend some analysts feel will return as the market grapples with several major headwinds such as Brexit and trade negotiations.
Growth investors typically search for companies that have higher profit growth and margins, while value investors look for stocks that seem inexpensive.
Shortly after the S&P hit its most recent record on Sept. 20, thanks to the outperformance by growth, especially technology stocks, the spread between the Russell 1000 growth and value indexes had surpassed the levels hit during the end of the dot-com era. The fourth quarter selloff helped that narrow but it began to widen again shortly before the new year.
"The valuation imbalance we have seen between growth and value in the largecap space ... when we have seen that inflection point in the past there has been a very powerful long-term rally where value has outperformed growth and we think that is coming up," said Phil Orlando, chief equity market strategist, at Federated Investors, in New York.
(Graphic: Historic spread between value and growth stocks - https://tmsnrt.rs/2V7L04a
(Graphic: Russell 1000 growth vs value spread - https://tmsnrt.rs/2VgekWh
In a recent note to clients, Morgan Stanley (NYSE:MS) equity strategist Michael Wilson said that the stocks that got hit first and hardest during last year's "rolling bear market" would lead the recovery this year and rally the hardest. That prediction appears to be playing out as areas such as transportation, considered cyclical value, have been among the leaders to the upside this year.
Wilson anticipated the Federal Reserve will hold off raising interest rates further and that the global economy would bottom in the first half. He favors value over growth, with a focus on cyclical over defensive stocks.
Value stocks also remain cheap relative to growth shares, with their widest forward price-to-earnings ratio spread in over a decade. And while investor worries about a recession, which helped fuel the fourth-quarter sell-off, have abated, a number of headwinds remain that could make value more attractive as market uncertainty rises.
"There are still a lot of headaches coming, whether it is Brexit, China - what is the (trade) package going to look like? - the legal stuff in Washington," said Steve DeSanctis, equity strategist at Jefferies in New York.
The Russell 1000 Value forward PE also sits right at its long-term average of about 13.8 while the Growth index is nearly 20, well above its historic average of 17.5.
(Graphic: Forward PE of Russell Growth and Value indexes - https://tmsnrt.rs/2Ep2nrw)
One challenge, even though value is relatively cheap, is that financials have a heavy weighting in value indexes and a Fed pause will make it harder for those firms to grow profits.
Even though, as of the last reconstitution of Russell indexes in June, the financial services sector saw the most significant decrease in index weight in the largecap 1000 value index, it still was 29.1 percent. In the Russell 2000 Smallcap Value financials command a weighting of 40.5 percent.
"If value is going to work, it has to be financials," said Mark Stoeckle, CEO at Adams Funds in Baltimore in an interview with Reuters.
"The one thing people were counting on in the first half of 2018 with the Fed was it was going to continue to raise rates, this (was) going to be good for banks – and not so much anymore."