Just as U.S. equities have outpaced those from abroad in recent years (see “Is It Time to Consider European Equities?”), so too have certain equity types fared better than others within the U.S. stock market.
Fueling much of the market’s gains over the past decade, for example, are so-called growth stocks (think Alphabet, Amazon and Apple). Although such stocks generally pay low or no dividends, investors are often willing to pay a premium for their exceptionally bright prospects.
Value stocks, on the other hand, tend to trade at a discount relative to their book value, cash flow and/or price-to-earnings ratio (think AT&T, Coca-Cola and Exxon Mobil). Such stocks tend to pay higher dividends, in part because their growth prospects aren’t nearly so rosy.
Historically, growth stocks have performed well during periods of modest economic expansion and low interest rates (as in recent years), whereas value stocks have excelled during periods of steady economic expansion and rising interest rates (such as the one we appear to be entering now).
So, after a decade of go-go growth stocks, is the pendulum ready to swing back in value’s favor?
Mind the gap
Looking back at the last cycle of interest-rate hikes, value stocks did in fact significantly outperform growth stocks. From June 2003 through June 2006, the Russell 1000® Value Index returned nearly 56%—as compared with roughly 30% for its growth counterpart.1
That said, there are two reasons why simply swapping out growth stocks or funds with their value-oriented cousins may not be the right move:
- Blurred lines: The distinction between growth and value stocks is far less pronounced than it once was. Tech companies, for instance, are often labeled as growth stocks; however, many are no longer the scrappy upstarts of yesterday but rather established, dividend-paying companies with healthy balance sheets and strong earnings. By the same token, companies once defined as traditional value plays are investing in new technologies and capitalizing on new growth opportunities.
- Timing: Even professional investment managers find it difficult to successfully time the market. If you reallocate resources from growth to value stocks too soon, for example, you risk missing out on gains you might otherwise have captured.
Mixing it up
That’s not to say investors should sit tight. The strong performance of growth stocks in recent years may mean they now comprise an outsize share of some portfolios. (Indeed, the performance gap between the Russell 1000 Growth Index and Russell 1000 Value Index is greater today than at any time since 2008—see “The growth decade,” below.) Investors in this situation might consider selling some of those growth stocks, if only to bring their portfolios back in line with their target asset allocations.
Another approach would be to combine traditional index funds, which screen and weight securities according to their market capitalization, with fundamental index funds, which screen and weight securities based on metrics such as sales, cash flow, and dividends and buybacks. Employing both strategies can deepen your diversification.
After all, growth stocks may or may not continue their winning streak, but it’s always a good idea to be positioned for a sudden sea change—and to rebalance if your portfolio has strayed too far from its target allocations.
1Schwab Center for Financial Research and Morningstar. Data from 06/01/2003 through 06/01/2006.
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