Growth Outperformed Last Quarter, But Value Is Still the Better Long-Term Bet
Investment Metrics believes that the July rally in growth stocks is only transitory.
Growth stocks made a comeback in the third quarter of 2022, but don’t expect the trend to continue for the rest of the year.
Almost every growth subfactor beat the market from July to September, while all but one value subfactor lagged the benchmark, according to the latest factor performance report from Investment Metrics, a Confluence company. While both value and growth stocks recorded losses for the second consecutive quarter, growth stocks showed more resilience amid the market turmoil, according to the report.
But Steve Reid, client success manager at Investment Metrics and the author of the report, thinks that there will be a value and growth reversal in the next few months. He noted in the report that part of the reason growth outperformed value in the third quarter was that the market was expecting a peak in interest rates. “That kind of sentiment proved to be premature,” he told II in an interview. “The September inflation numbers ended up being still close to the record high. They weren’t coming down as fast as investors had hoped.”
Value stocks have outperformed growth equities in seven of the past nine months, according to IM data. The most notable exception to that trend was July, when the Federal Reserve raised its benchmark interest rate to 75 basis points for the second straight month. The aggressive tightening initially led to a stock market rally, but that ran out of steam in the following months.
“Rising interest rates and bond yields do not favor growth stocks, [because] capital-intensive growth projects are now more expensive to finance,” Reid said. “Value stocks generally have a stronger cash-flow profile and tend to outperform during [economic downturns].”
In Europe, growth stocks also outperformed value stocks in the third quarter. According to the IM report, subfactors such as dividend growth, sales growth, and forecast growth all beat their respective benchmarks by at least 50 basis points. All value subfactors underperformed the market, with the sales-to-price subfactor lagging by as much as 150 basis points. But over the next few months, Reid expects value stocks to take the upper hand in Europe, for the same reason he thinks they’ll outperform in the U.S.
“The primary factors driving the market weakness remain, including inflation, [higher] interest rates, the war between Russia and Ukraine, the ongoing European energy crisis, the U.K.’s economic woes, [and] China’s Zero-Covid policy,” the report said. It added that all of these events tend to lead to a prolonged market downturn and the outperformance of value stocks.
Nevertheless, Reid doesn’t want to completely rule out the possibility of growth outperformance. The upcoming earnings season will serve as a weather vane, he said. If growth-oriented companies like Tesla and Apple are able to deliver robust financials, “that would be a strong case that growth stocks are going to rally,” he said.