Here we are again, front row seats to the value versus growth battle. Is now, finally, value’s turn to take the lead?
Recent asset flows into some big value ETFs have folks looking for signs in the tea leaves. The iShares MSCI USA Value Factor ETF (VLUE) has now taken in almost $900 million since Sept. 1.
Other value ETFs such as the Vanguard Value ETF (VTV), the iShares Russell 1000 Value ETF (IWD) and the Vanguard Small-Cap Value ETF (VBR) have all been gaining attention as growth stocks face a sudden faltering of investor confidence.
The Invesco QQQ Trust (QQQ), which has been one of the poster children for the immense appetite for growth this year given its big weighting in tech stocks and consumer discretionary names—about 85% of the portfolio—has dropped 9% so far this month, giving up some $1.3 billion in assets.
There’s a narrative out there suggesting factor rotation out of things like momentum and into things like value and small caps is taking place. The story goes that growth is overdone, overvalued. Cyclical value stocks—and cyclical segments—beaten down and overshadowed by the outperforming secular growth names, are due for their time in the sun, especially since the broader stock market seems to have hit some sort of top (temporarily?) this month.
Major Stock Indices Title To Growth
Remember that many major indices—the S&P 500, Russell 1000, Nasdaq-100—are largely growth indices today due to their large allocation to technology and growth stocks. And so far in September, it’s value that’s holding on better (as measured here by IWD):
Chart courtesy of StockCharts.com
Growth valuations are rich, no doubt. That’s not surprising given their massive run-up this year. (QQQ is up 27% YTD; IWF up 20%. Gains for both these ETFs since the March 23 market low currently sit at 58%).
The Russell 1000 Growth Index is currently trading at 28.5x next year's earnings estimates, the highest level since 2000, when it hit 33.3x. This growth index is also trading at a 33.8% premium to the P/E for the broader Russell 1000 Index (21.4x), and a 71% premium to the P/E for the Russell 1000 Value Index (16.7x).
The gist here is that growth is trading at its highest premium to value since 2000, when it hit 133% premium. (For perspective, the average growth/value premium in the last 25 years has been 32%.)
Growth Is Rich, Value Depressed
The appeal of a downtrodden segment such as value is clear: The potential for outsized gains is much bigger. It’s the allure of the underdog. But let’s state the obvious: Two weeks don’t necessarily make for a new trend, and market timing is a fool’s errand, one that in value investing has proven to be a persistent money-losing proposition for a very long time.
“In the internet mania of the late ’90s, you had ridiculous valuations and plenty of ‘this time it’s different’ folks who felt that the internet was the future, and that no other businesses would ever survive,” said Alpha Architect’s Wes Gray. “I remember feeling the ‘mania’ element and understanding that it was insane.”
“That mania was a true mania, because the firms that were valued so highly had no actual economic footing, such as no free cash flow, no defensible business models, etc. It was all hot air,” he explained. “Maybe you have that in Tesla and some other niche cases in today's market, but this situation is not the internet bubble.”
This Is Different Than 2000
Yes, tech stocks have been burning hot, but according to Gray, the difference is that today “we are dealing with some real businesses, generating huge revenues, huge cash flow and defendable business models.” Amazon. Microsoft. Netflix. Google. These are all names that everyone depends on today, especially in the year of a global pandemic.
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
“Are they worth 50x earnings? Probably not. But I also wouldn't bet against sentiment and momentum on these things. At 100x earnings, maybe,” Gray said. “The situation we face now doesn't scream ‘mania.’ It screams ‘strong sentiment and overvaluation for mega cap tech stocks.’ But that doesn't provide enough gusto for me to make bold calls on ‘now is the time for value to come back.’"
Either way, money has been chasing value in recent days. Among the biggest U.S. value ETFs, most funds have seen net creations so far in September. VLUE has taken in $900 million in net new assets, VTV has attracted $870 million, IWD has picked up almost $600 million; VBR has attracted $590 million. The list goes on.
Vanilla Value In Demand
Noteworthy in these numbers is that the hunt for value seems to be materializing in some of the broadest, most vanilla and cheapest value ETFs.
VLUE, specifically, may be leading the charge in demand thanks to its "market-like" relative approach. The fund looks for value stocks based on several metrics, but it takes into account market sector dynamics that put in perspective valuation of different stocks. In the end, that means that, unlike most value ETFs, VLUE has a big allocation to technology and to consumer discretionary names instead of the tilt to financials and energy you tend to see in value funds. These tech and consumer names aren't the growth high-fliers of 2020, but they offer investors access to value without having to give up on tech.
The smart-beta-y strategies such as the $650 million quant First Trust Large Cap Value AlphaDEX Fund (FTA), the fundamental-weighted Invesco S&P 500 Pure Value ETF (RPV) or the actively managed Avantis U.S. Small Cap Value ETF (AVUV) and American Century Focused Large Cap Value ETF (FLV) are trailing in the asset gathering race, with creations so far in September totaling less than $10 million each.
It could be that jumping into the value bottom-hunting trend is risky enough for many investors who see a departure from cheaper vanilla strategies too far a bridge to cross right now. They may see it as adding another layer of risk to an already risky proposition.
Or maybe it’s just too early to call for conviction in value investing across the board since this perceived exodus from growth ETFs has yet to be a unanimous event. QQQ has now bled $1.3 billion so far in September, but VUG—the biggest growth ETF—has picked up $1.4 billion so far this month, the bulk of which came in this week.
Consider flows trends in September and since the March 23 market low across various pairs:
Sept. Flows ($M)
Flows Since 3-23-20
In the end, this value versus growth debate is heated and it’s fun, but it keeps circling back to the same big picture issues we were talking about last year. Consider ETF.com’s Sumit Roy’s observations on this debate in 2019:
“Growth ETFs are predominantly made up of technology, consumer discretionary and communication services stocks. For value to start outperforming growth on a sustainable basis, sectors like tech will likely have to fall out of favor relative to sectors like financials. Could that happen? Certainly. But there are secular trends in tech (the rise of cloud computing and artificial intelligence) and financials (low rates and flat yield curves) that could make that reversal difficult.
On the other hand, regardless of secular head winds or tail winds, perhaps tech has simply gotten too expensive relative to financials. After all, the last time value outperformed growth was in the years following the bursting of the dot-com bubble in 2000. While they were growing ferociously, tech valuations had gotten far too heated, leading to a long period of underperformance.”
Looking at returns year-to-date, growth is far ahead, IWF is up 30% to IWD’s 4%. In September, though, that has flipped, with IWD taking the lead by 6.5 points.
If you believe recent performance amounts to a bona fide trend, then value is your friend. And there are plenty of value ETFs to choose from.
But longer term, to Roy’s point, it would take technology underperforming financials and energy for value to continue to outperform growth. Certainly, crazier things have happened. And 2020 has been the year of crazy things. But call me a skeptic.
Consider sector allocation differences in IWF versus IWD:
Technology represents 44% of IWF versus 9% for IWD.
Financials represent 2% of IWF versus 19% for IWD.
Consumer discretionary represents 17% of IWF versus 7% for IWD.
Energy represents 0% of IWF versus 4.5% for IWD.
Contact Cinthia Murphy at firstname.lastname@example.org