Growth Stocks Have Outperformed Value Over the Last Decade, But What Might the Future Hold?
Growth: Insights from Raj Shant, Managing Director at Jennison Associates
The landscape of investing has seen a significant shift over the past decade, with growth stocks consistently outperforming their value counterparts. Growth investing, characterized by the purchase of equities expected to grow at a faster rate than the market average, has garnered considerable attention from investors. This trend is largely attributed to the anticipation that growth stocks will experience rapid increases in share prices, making them an attractive option in a dynamic market.
In the current high-interest-rate environment, growth stocks have continued to thrive. However, as we approach a potential interest rate cutting cycle, the outlook for these innovative companies may become even more promising. Historically, growth equities, as represented by the Russell 1000 Growth Index, have outperformed value stocks, mirrored by the Russell 1000 Value Index, particularly when the 10-year US Treasury yield falls below 4 percent. This correlation suggests that a decline in interest rates could provide a significant boost to growth stocks.
Despite concerns that growth valuations may be stretched, this perception may overlook the underlying earnings growth that supports these valuations. Current growth expectations remain robust for 2024 and 2025, indicating that growth stocks are not as overvalued as some might believe.
Growth stocks typically exhibit organic growth and are less susceptible to economic fluctuations, making them more resilient in subpar economic conditions. As the broader economy slows, stocks with durable earnings growth become increasingly attractive, positioning growth stocks favorably in a decelerating economic environment.
If the Federal Reserve successfully navigates a soft landing, lower discount rates could enhance the net present values of long-duration assets like growth stocks. This scenario, combined with solid fundamentals and strong secular growth themes, could provide global equities with ample room for further appreciation.
While macroeconomic factors can cause short-term volatility, the transformative potential of innovative technologies, particularly in the realm of artificial intelligence (AI), presents ongoing opportunities for growth investors. The generative AI revolution is poised to be as impactful as the advent of the internet and mobile computing. The global AI market is projected to surge from $96 billion in 2021 to an astounding $1.8 trillion by 2030.
Online Consumption Trends
The demand for AI and the advanced computing power it necessitates is driving growth across chip and silicon companies. We are currently in the infrastructure build-out phase of the AI cycle, where the necessary computing capabilities must be established before applications can be fully developed. This trend is expected to extend beyond technology providers, creating substantial use cases across various industries in the coming years.
In the luxury goods sector, while global consumer spending is moderating, the trend does not indicate severe distress. Younger demographic groups with healthy disposable incomes are reshaping consumption patterns, sustaining demand for luxury brands. Notably, online consumption has become a major driver, with approximately 80 percent of total luxury sales being digitally influenced.
Chinese consumers represent the largest segment of the luxury market, accounting for around 30 percent, followed by consumers in the United States. Although China’s economic growth has shown signs of weakening, the luxury market continues to thrive, bolstered by strong demand from affluent Chinese consumers traveling abroad. We remain optimistic about global consumer brands with direct-to-consumer business models and omnichannel distribution networks.
In the healthcare sector, we see promising growth opportunities, particularly in cutting-edge treatments for diabetes, obesity, and rare diseases. Companies like Eli Lilly and Novo Nordisk are leading the charge in the obesity market, where demand is expected to outstrip supply in the coming years. Additionally, the rise of financial technology platforms, especially in Latin America, is noteworthy. Neobank penetration in South America is projected to reach 20.1 percent by 2027, significantly higher than the 10.6 percent recorded in 2022. Furthermore, the number of digital commerce users in Latin America is expected to exceed 292 million by 2028, more than double the figures from 2020.
As interest rates begin to decline, the environment remains favorable for growth stocks. While macroeconomic uncertainties, such as stagnating Chinese growth, ongoing geopolitical conflicts, and the upcoming US presidential election, may introduce volatility, we believe that focusing on secular growth companies with visible earnings and solid fundamentals will be the most effective strategy for navigating the uneven path ahead.
Value: Perspectives from Alison Savas, Investment Director at Antipodes Partners
The ultimate goal of all investors is to purchase stocks today and sell them at a higher price in the future. Both growth and value investors operate under the premise that their chosen stocks are undervalued at the time of acquisition. However, value stocks are specifically defined as those trading at a price lower than their intrinsic worth. It is also unlikely that any investor would buy a stock if they suspected its earnings were on a downward trajectory.
Every investment possesses both value and growth characteristics. The key determinant of an investment’s success is the price paid for its growth potential. Overpaying for future earnings or encountering disappointing growth can lead to significant losses, regardless of the company’s quality. A historical example is Microsoft during the dot-com boom, where it reached a staggering 70 times earnings due to soaring growth expectations. However, following the tech crash, Microsoft’s earnings continued to grow but at a slower pace than anticipated, resulting in a substantial de-rating of its stock price. For those who invested in Microsoft in 1999, it took 15 years to recover their investment.
This historical context is crucial as growth stocks have significantly outperformed value stocks over the past decade, leading to a substantial premium on growth stock valuations. Currently, growth stocks are trading at the upper end of their 30-year valuation range, while value stocks are priced at a considerable relative discount. This disparity is noteworthy, especially considering that investors are willing to pay 19 times earnings for growth stocks compounding earnings at 7 percent annually, compared to only 10 times for value stocks with similar growth rates.
The concentration of a few dominant companies—Nvidia, Apple, Microsoft, Amazon, Alphabet, and Meta—accounting for 35 percent of the MSCI AC Growth Index raises concerns. Historically, such concentration does not persist, and the reliance on a handful of companies for growth performance creates vulnerabilities in the market.
Vulnerable Profit Pools
The concentration of returns among these six companies, which also represent 34 percent of the MSCI ACWI’s gains over the past year, underscores the risks associated with investing in growth stocks. The future performance of these companies is closely intertwined, and the potential for disruption in a market-based economy means that large profit pools are often subject to competitive pressures.
While there have been signs of a broadening market performance in recent months, the case for a fundamental shift towards value investing is strengthened by the extreme valuation dispersion between growth and value equities, despite minimal differences in their growth profiles. The high correlation within the growth cohort further complicates the investment landscape.
We anticipate that value investing will eventually outperform growth, but it is essential for investors to adopt a nuanced approach. Simply investing in the cheapest quartile of stocks with the expectation of mean reversion may overlook structural changes that render certain stocks cheap due to competitive disadvantages or permanent impairments.
Avoiding both growth traps, as exemplified by Microsoft in 1999, and value traps is crucial for successful investing. A pragmatic approach to value investing, focusing on the right price for a company’s resilience and growth potential, will help investors navigate the complexities of the current market environment.