Growth Beat Value in the First Half of 2023. Will Its Outperformance Last?

Better economic conditions are needed for value stocks to make a sustainable rebound, according to Los Angeles Capital Management’s Hal Reynolds.


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The momentum driving growth stocks isn’t going away — at least in the short term.

In the first six months of 2023, almost all growth sub-factors, such as earnings growth and sales growth, beat their respective benchmarks, according to the latest factor performance report by Confluence. Meanwhile, all value sub-factors — including book-to-price ratio, earnings yield, and cash flow yield — lagged their benchmarks by at least 2 percentage points. Sub-factors are more granular measurements of broader investing factors such as value, growth, and quality.

But investors have started to show a stronger preference for value stocks in the past two weeks, according to Hal Reynolds, co-chief investment officer at quantitative investment firm Los Angeles Capital Management. LACM tracks investor demand for different factors to make projections about their future performance.

Factor return data also show that value has been having a better run in July. The Russell 2000 Value Index has returned 5.5 percent month-to-date, significantly higher than the Russell 2000 Growth Index, which returned 2.7 percent.

“The question is, is that the beginning of a new value cycle?” Reynolds asked. He added that investors have gotten used to shorter value and growth cycles over the past three years. As a result, even a short period of value outperformance could lead investors to question whether the growth cycle is near its end.

Reynolds doesn’t think so. “It’s a bit premature to think we are in a value cycle,” he said. From a historical perspective, value stocks need better economic conditions for a meaningful rebound, he added. For example, banks — which make up a third of most value indices — usually thrive when the yield curve is positively sloped. But the yield curve is currently inverted, suggesting that investors have a pessimistic outlook on long-term economic conditions.


In terms of growth stocks, Reynolds thinks the artificial intelligence frenzy isn’t over and will continue to fuel the performance of mega-cap tech stocks. “I think the demand for AI . . . is only going to accelerate,” he said. That’s due in part to weakening global demographic trends, which will prompt rapid adoption of AI tools aimed at enhancing productivity, according to Reynolds. In addition, Reynolds believes the recent rise of growth stocks is justified by strong fundamentals. “Dividend discount returns for growth, relative to their history and relative to value, look reasonable to us,” he said.

“Active managers are almost always underweight in the mega-caps,” Reynolds added. “There are a lot of theories that suggest you should underweight them . . . But at the same time, those stocks often have characteristics that are preferred by investors. When you underweight them, you do that at your own peril.”