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When value sectors like financials, energy and industrials outperform growth sectors like technology and communications, it usually means a bargain is to be had in the former with bright prospects for fundamentally driven price appreciation. However, this does not fully explain why value outperformed at the start of the year.
“The value and the cyclical trade are closely linked. Investors are buying value stocks because many of the cyclical sectors fall into that category and they believe in a cyclical recovery,” the team says. “They’re not buying value stocks only because they’re cheaper than growth.”
To the team’s point, although financials are currently the cheapest sector in the S&P 500 on a forward P/E basis, as of 2/5/21 they were trading at 14.1x forward earnings,1 which is above their 5-, 10- and 20-year averages.2
“According to their history, these sectors are not cheap on a relative basis. Record amounts of liquidity and the prospects for a brighter economic future have driven valuations up across the market,” the team says. “Also, when it comes to the value-versus-growth trade, things just aren’t as black and white as they seem.”
For instance, while value stocks do comprise much of the cyclically sensitive areas of the market, believing only those sectors will do well in the recovery is flawed because it discounts the role growth stocks will play.
To understand why the impact of growth stocks should not be ignored, the team highlights the long-term potential of technology. The US is currently in rebound territory, the team says, and the recovery and creation of new growth will not truly begin until it reaches the pre-crisis GDP level. Additionally, the labor market will be smaller than it was prior to the pandemic because some of the jobs that were lost are not coming back.3 Until the US reaches pre-pandemic levels of employment, the smaller labor force will need to be more productive in order to drive new economic growth, the team says.
“When we get back to that previous level of GDP and expect to keep growing, the people who are left in the labor force have to be more productive than they were before,” the team says. “How do you get more productive? Technology. Therefore, we think there’s a lot of opportunity over the next 1-3 years in that growth space.”
Of course, you could (and many commentators do) make the argument that tech stocks are overvalued.4 But here, the team points out that to make that assumption would be to paint the entire sector with too broad of a brush. There are areas within technology that still show promise from a long-term perspective, such as small- and mid-cap technology. Many of the companies that will be necessary in a new low-touch consumer economy fall into that space and shouldn’t be ignored.
The long-term resilience of technology, and the fact that small caps tend to outperform large caps coming out of a recession, may be an attractive way to participate in the economic recovery, without tilting too far towards value and missing out on secular technology adoption.
When asked whether or not the prevalent nature of high-growth sectors only pertains to the US, the team says, “I think the story is roughly the same everywhere. The world needs technology.”
“Globally, we’ve become more dependent on technology due to COVID and that has driven further and faster innovation, which creates opportunity for investors. Diversification is still critically important, and a cyclical recovery can drive many sectors forward, it’s not a zero-sum game between growth and value” the team concludes.
1 Factset: Earnings Insights. January 29, 2021.
2 Factset: S&P 500 FORWARD P/E RATIO HITS 19.0 FOR THE FIRST TIME SINCE 2002. February 21, 2020.
3 NY Times: A shift toward permanent job loss continues. January 20, 2021.
4 Quartz: Is a massive bubble in Us tech stocks coming—or is it already here? December 15, 2020.
S&P 500: The S&P 500 is an index designed to track the performance of the largest 500 US companies.
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