Report Updates
We have updated reports on Fiera Capital (FSZ) and Parkland Fuel (PKI). Both companies had good quarters beating expectations on multiple metrics. One is focused on successfully implementing a new global organic growth strategy and the other is likely to benefit from economic tailwinds and trades at a discount to peers.
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Market Update
There has been a lot of talk about a market rotation from growth to value beginning in February and this can even be seen to a certain extent in broad market indexes. While the Nasdaq clearly had an awesome year in 2020, outperforming other indexes with the run-up in tech and growth during the pandemic, it is now underperforming on a year to date basis in 2021 up only 3.3% while the Dow Jones, S&P500 and TSX are up in the 9-11% range. Interestingly, The Nasdaq, SPX and DJI are now roughly ‘tied’ on a one-year basis at a 45% return. Meanwhile, the TSX is up 'only' ~30%, reflecting an overall stronger recovery thus far in the US.
We think there is more to what we are currently seeing in the markets than just a “rotation” from growth to value. There are other things to consider including the degree to which sectors were affected by the pandemic, their sizes and the fact that we are coming out of pandemic, the likes of which we have never experienced before. For this market update, we will look at the performance of growth, value and different market caps in the near term and how we would view the ‘rotation’ going forward.
The charts below represent the cumulative performance of value and growth and a combination with different market caps relative to the S&P500, which we will consider as “Core equity”.
The Value and Growth Rotation
First, let's look at value and growth in isolation:
On a YTD basis, the "rotation" seems clear. However, zooming out over the last year this rotation seems a bit less obvious with value and growth crossing over each other a few times (chart below). This makes sense given the strange market we have seen over the last year due to COVID. With such a steep run-up in growth and tech stocks during the pandemic, a sharp short-term correction is not surprising. Many value stocks are also cyclical which typically do well in an economic recovery and are expected to bounce back even more coming out of the pandemic. All of this has likely further exasperated the rotation from growth to value.
Like many other comparisons in investing, under/outperformance depends on what point in time you start measuring. The further back we go with growth and value, the less clear it becomes how “real” this rotation is. Zooming out even further to 10 years we see that there have been other instances when growth and value cross over, taking turns being the “outperformer” compared to the S&P500, particularly from 2011-2017, with growth vastly outperforming thereafter.
A question that comes to mind here is: How much does growth need to correct and value need to appreciate for this to be consibedered a real rotation?
Growth still seems to be the overall winner in the long run. However, in fairness, it can be argued that plain-vanilla “value” ETFs and indexes often simply look for companies that are trading at a P/E below average market level. A low P/E is not necessarily a sole metric to go by when looking for companies with strong return potential. In fact, many companies have low P/E’s because of weaker fundamentals and slow growth. So, it would not be unreasonable to attribute some of the underperformance of value to “value traps”. On the other hand, an index that tracks companies with growth characteristics is arguably a more reliable indicator for long-term capital growth.
Does size matter?
In the charts below, we can clearly see that value has outperformed so far this year, and in particular, small-cap and mid-cap value compared to large-cap value. Here we almost see a mirror image with small and mid-cap value being the best performing ‘styles’ and small-cap growth being the worst performer, on a YTD basis. This could be explained by investors adjusting their risk to reward outlook by moving away from unprofitable small growth stocks viewing them as too risky, especially given concerns over interest rates and inflation. On the other hand, small caps tend to outperform in an economic recovery, giving “undervalued” small-cap stocks a more interesting risk/reward set up. Put differently, small caps with low P/E’s might present less downside risk than their higher P/E growth counterparts, while also providing upside potential associated with an economic recovery.
It is also worth noting here that both small-cap and large-cap growth have done very well over longer time frames compared to the rest. Large-cap growth stands out, in particular, showing far less volatility than small-cap growth and outperformed it by about 30% on a cumulative basis over 10 years.
Differences in sectors
It is also worth noting here the differences in sectors. For example, the top sectors in the small-cap growth index are technology, health care, industrials and consumer discretionary, all of which saw strong rallies during the pandemic and are now seeing a correction. This is in contrast to small-cap value whose top sectors consist of those that will likely benefit from an economic recovery like financials, industrials, consumer discretionary and real estate. While industrials and consumer discretionary are common to both small-cap value and growth as top sectors, they contain different subsectors that will likely react differently to the reopening of the economy. For example, industrial companies can be both renewable energy equipment companies (strong rally in 2020) or construction companies (to benefit in post-pandemic). Consumer discretionary companies can be e-commerce companies or physical retail stores etc.
What does this mean for investors?
We think it is important for investors to differentiate between the general market sentiment and risk appetite and the negative performance of an individual stock based on its fundamentals. As always, we are reluctant to make conclusions based on the short-term movements in stocks. Additionally, investors should keep in mind that more volatility should generally be expected when investing in growth stocks compared to value. Will value begin to outperform growth going forward? Based on historical trends, we think it is far too early to make that call. Growth still holds the upper hand when looking out over longer time periods, but ‘value’ indexes do not necessarily reflect a true value strategy. The recent shift from growth to value may also highlight the role ‘style diversification’ can play in reducing overall portfolio volatility in the near term.
Finally, regardless of whether one takes more of a growth or value approach to investing, we think focusing on fundamentals will continue to be the key to long-term success.
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