NEW YORK (Reuters) – One indisputable fact has underpinned the recent end of the long-running US bull market: the payment of growth stocks at any price has paid off enormously.
Traders work on the floor of the New York Stock Exchange (NYSE) in New York, USA, October 24, 2018. REUTERS / Brendan McDermid
Paying a premium for stocks of fast growing companies like Amazon Inc (AMZN.O) and Google Parent Alphabet Inc (GOOGL.O) for those considered to be good value for money has been a recipe for success for more than five years. Growth stocks have outperformed their competitors in this period with a margin of more than two to one.
Last month, the wheels have dropped off this profit vehicle. The Russell 1000 Growth Index .RLG, which trades at high prices relative to its gains, has so far dropped more than 10 percent in October, the worst performance since the financial crisis. Over the same period, the Russell 1000 Value Index .RLV fell only 7 percent.
This shift became apparent last week, after large drops in Amazon and Alphabet sales triggered the largest price declines in years. Nasdaq .IXIC, in particular with growth companies from the technology sector, is in a complete correction – the term for a decrease of at least 10 percent compared to the latest high.
Earlier this month, Russell's performance gap between Russell's growth and value indices reached its highest level for at least 40 years. Earlier cases of such expansion led to a comeback of value stocks, which names such as JPMorgan Chase (JPM.N), Exxon Mobile (XOM.N) and Johnson & Johnson (JNJ.N), and has driven rotational speculation.
"When the rotation returned in the other direction, a kind of return to the mean, the value exceeded several years of growth, it was a long-term return to mediocre trading," said Phil Orlando, senior stock market strategist at Federated Investors in New York.
The S & P 500 .SPX has fallen around 9 percent since its high on September 20, with some of the year's top performing sectors, such as .SPLRCT and Consumer Discretionary .SPLRCD, contributing to the decline.
Both sectors have been down for three weeks and contain growth stocks such as Amazon and Alphabet, leading some market participants to believe that full rotation in value stocks is under way.
According to FTSERussell, technology in the Russell 1000 growth index is nearly 35 percent, followed by a 18.8 percent share in the consumer discretionary sector.
Even after the recent downturn, growth stocks based on the forward price-earnings ratio remain expensive, making the argument more convincing for value stocks as investors have concerns that have helped sell-sell.
Steve DeSanctis, equity strategist at Jefferies, New York, said there are good reasons to own value stocks now.
"We're starting to see profits accelerating faster in value than growth, and if GDP is going to be north of 3 percent we should see a pretty good earnings backdrop," said DeSanctis.
Third quarter gross domestic product, which was reported on Friday, reached an annualized growth rate of 3.5 percent.
However, questions remain as to whether the value shift will be a full rotation when the bull market enters its late cycle phases, or just a temporary defensive move during a selloff, similar to the beginning of the year when the S & P 500 was corrected into territory in February.
One thing that differentiates the current environment from the beginning of this year is that the Federal Reserve seems more determined than ever to raise interest rates, said Julian Emanuel, chief equity and derivatives strategist at BTIG New York. This has led to higher returns on US Treasury securities.
"Investor psychology has moved on to the idea that long-term returns are rising, and if that happens, that's an implicit disadvantage for high-multiples stocks that tend to be in the growth category," said Emanuel.
In addition to the US Federal Reserve's interest rate hike, investors' concerns have led to slowing China and a stronger dollar, which in turn weighs on emerging markets and corporate profits of large multinationals.
"The Fed says we keep moving, steady rate hikes, and people are shocked and outperformed in light of weak global issues," said Alec Young, managing director of global market research for FTSE Russell, New York.
However, investors may lose profits if they now move too high in value should the pendulum strike back before the cycle comes to an end.
Not all market participants are convinced that the end of growth stocks is near.
"If you believe that value will outperform, think more at the end of the cycle," said Scott Wren, senior global equity strategist at Wells Fargo Investment Institute, St. Louis, Missouri. "As for the consistent meaningful outperformance by value, this will not happen until we've overcome the next recession."
Reporting by Chuck Mikolajczak and Sinéad Carew; Edited by Leslie Adler