Opportunity Still Alive in Value Stocks
The benefits of a growth/value blend
We believe it’s important to own both growth and value stocks in a portfolio. A blend of the two investment styles has offered the most compelling risk/reward over time, as shown in the Better together chart below, balancing the historically higher volatility in value and lower return in growth.
Our research also reveals that growth and value are essentially anti-correlated: One generally thrives in an environment where the other lags, and vice versa. This means investors can build a more resilient, all-weather portfolio by incorporating the relative strengths of both growth and value – and can potentially enhance those results by working with astute managers that can consistently beat their growth/value benchmarks.
Risk and reward for growth, value and blend, 1926-2020
Source: BlackRock, with data from the Kenneth R. French Data Library. Growth is defined as the lowest 30% of companies in the universe as ranked by the book-to-market ratio, which is calculated by dividing a stock’s book value by its market capitalization. Value is defined as the highest 30% of companies in the universe as ranked by the book-to-market ratio. Blend reflects a 50/50 blended return of growth and value. The reward/risk ratio is calculated using monthly data from July 31, 1926, to Dec. 31, 2020. The reward/risk ratio is defined as the annualized portfolio return divided by the annualized standard deviation of the portfolio.
Scope to increase value
While both growth and value extend benefits, portfolios may have room for greater value exposure. Market indexes typically tilt toward growth stocks. Because investors assign higher prices to growth stocks, they carry higher market capitalizations – and greater representation in market-cap-weighted indexes. The S&P 500 Index was 67% growth stocks as of mid-February 2021. Value is similarly underrepresented in investor portfolios. A BlackRock Portfolio Solutions (BPS) review of more than 18,000 advisor model portfolios at year-end 2020 showed 62% were underweight value.*
BlackRock’s Fundamental Equities investors have identified the opportunity and are closing the growth/value gap. The most recent data for U.S. portfolios showed a platform-level shift toward value after a long-held pro-growth bias.
Shorter- and longer-term tailwinds
We believe now is a particularly good time to consider increasing value positions, as recent strength could have staying power not seen in years.
The key near-term booster, as we outlined in a recent Market Minute, is value’s history of outperformance in the period rising out of a recession. Cyclically oriented value stocks were the most depressed in the COVID-driven downturn and, we believe, have more room to run in the recovery period.
In the longer term, we see a higher inflation regime as supportive of value stocks. While we don’t see rising inflation as an imminent issue, it is a real risk in the medium term. As we discuss in our latest equity market outlook, the coronavirus crisis compelled the biggest global fiscal and monetary stimulus seen in the post-WWII era. Combined with pent-up demand accrued during lockdowns and consumer savings waiting to be unleashed, the risk for rising inflation is higher than it has been in decades. The BlackRock Investment Institute sees a higher inflation regime in the next five years.
Value’s edge amid rising inflation
Value equities have historically demonstrated greatest outperformance during inflationary episodes.
We looked at data back to 1927 and found value has outperformed growth by the largest margin in periods of moderate to high inflation, as shown in the chart below. It is only when inflation is very low that value performance pales – as evidenced in the past 10 years. Notably, it does not take runaway inflation for value to gain an edge. Value outpaced growth in the period of middling inflation, which ranges from 1.1% to 4.4%. This is more in keeping with our outlook this cycle versus the highest inflation periods that averaged 8.4%.
History of inflation fighting
Value outperformance by inflation regime, 1927-2020
Source: BlackRock, with data from the Kenneth R. French Data Library and from Robert J. Shiller. Fama/French data utilizes the CRSP universe, which includes all companies incorporated in the U.S. and listed on the NYSE, AMEX or NASDAQ exchanges. The level of annual inflation is defined as the year-over-year change in the Consumer Price Index (CPI). “Lowest inflation” represents the bottom 20 years of inflation readings; “highest inflation” represents the top 20 years; and “middling inflation” represents the remainder. The numbers below represent the high-low range in inflation readings for each regime. Value outperformance is annualized and calculated across various inflation regimes using annual data from 1927 to 2020. Value outperformance represents the performance of value stocks minus growth stocks, as defined by the Fama/French HML research factor (i.e., “high valuation minus low valuation” using book to price).
Actively managing risks
Whether focused on growth or value, we see an active approach as critical in the current environment where each presents distinct risks.
In the value universe, the key is avoiding “value traps” – companies that are cheap for good reason and unlikely to appreciate. In growth, the question is whether companies can continue meeting investors’ lofty expectations. This means distinguishing between those companies that can continue to deliver earnings growth in a post-COVID world and those where demand was simply pulled forward during the pandemic, pinching future earnings potential. We believe navigating these risks well requires the expertise of a skilled active manager.