US value stocks staged a strong recovery in September after an extended period of underperformance. While value slipped again in early October, we’re monitoring four signals that might indicate whether we’re on the cusp of a bigger value rebound.

Since 2017, US growth stocks relentlessly powered ahead of value stocks. Ultralow interest rates and fears of a weak macroeconomic growth recovery have suppressed stocks with attractive valuations, which tend to be more sensitive to the economic cycle. At the same time, the ever-increasing popularity of mega-cap technology and new media names captured the imagination of investors who seek to tap sources of growth in a low-growth world.

Growth-Value Gap Looks Stretched

But in September, change was in the air. The Russell 1000 Value Index advanced by 3.6%, outpacing the Russell 1000 Growth Index, which was flat (Display). In early October, the style winds turned against value once again. Still, several trends suggest that the preference for growth over value stocks may have run its course.

The S&P 500 Index has come through an extended period during which growth-style stocks outperformed their value-style peers. By some estimates, the current extreme difference between growth and value performance matches that experienced prior to 2000 and 2009. Both of those years proved to be the beginning of multiyear periods of great returns for value stocks. As a result, sector valuations look distorted: the price/forward earnings of US technology stocks is 9% above its long-term average since 1990, while financials are trading at a 9% discount to their long-term average.

Of course, these trends don’t guarantee that value stocks will come charging back. However, some key signals could help identify whether value stocks are poised for a longer-term recovery.

  • Stabilizing or improving economic trends: For several quarters, pessimism over economic growth has become pervasive among investors. In 2019, consensus expectations for economic growth and Fed policy have turned around. Just 12 months ago, the 10-year Treasury yield was 3.2% and consensus expectations called for additional Fed rate hikes and more balance-sheet shrinkage. By quarter-end, the 10-year Treasury was at 1.67%, while the US Federal Reserve has cut interest rates twice. Meanwhile, the trade war with China and the inverted yield curve have added to recession fears. These concerns are understandable, but may be overdone. We believe that if we begin to see positive economic surprises, this may counter the current pessimism and could lead to better performance for economically sensitive stocks. In fact, the Bloomberg Economic Surprise Index reached an 11-month high in September (Display).