GMO Says the Growth Bubble Hasn’t Popped Yet
The value firm’s asset allocation team says there are still opportunities for going long value and shorting growth.
Growth stocks fell hard in the first half of 2022, but the bubble may not have burst quite yet.
Against a backdrop of declining growth performance, the asset allocation team at GMO wrote last week that there are still opportunities in going long cheap value stocks and shorting expensive growth equities — the approach GMO uses in its equity dislocation strategy, which launched in the latter part of 2020.
“At least until very recently, the insatiable desire for growth equities had pushed valuation disparities to levels not seen since the peak of the internet bubble,” the team wrote. “Unlike that period, however, this one has permeated much more widely, touching all sectors and all countries.”
Over the past five months, the MSCI ACWI Growth index has fallen 21 percent, while the MSCI ACWI Value only fell 4 percent. For this reason, GMO said its clients have become skeptical about the future of investments in the equity dislocation strategy.
To quell these doubts, GMO staffers set out to determine the estimated value of the equity dislocation strategy for the end of May. The team divided the price-to-fair value ratio of the most expensive fifth of stocks by the ratio of the cheapest fifth of stocks. The resulting ratio for cheap stocks relative to expensive ones was in the ninth percentile since 1990.
“This indicates that there is still a tremendous amount of scope for cheap to outperform expensive in order to return to a more normal valuation differential,” the team wrote. “Although there are a couple of exceptions, it is heartening to see that the opportunity remains broad based across the globe, with the majority of the world exhibiting a spread of valuations around the 10th percentile.”
GMO wrote that this proves that the growth “bubble has deflated somewhat [but] it has yet to fully burst.” Instead, GMO said the spread between value and growth at the beginning of the year was “so extreme” that further reversion is still needed to get back to a normal level.