A year ago, we posted this piece showing the wide gap between the returns of the Russell 2000 Growth (RUO) and Value (RUJ) indices. At the time, RUO’s relative outperformance was approaching two standard deviations above average, measured on a rolling 52-week basis. The gist of the post was that it was a large difference, but not abnormal, with the implication that the trend should reverse, but not sure when. With another year of data, we can see how things have played out.
Source: Bloomberg, 361 Capital. ROU minus RUJ weekly price returns, compounded on a rolling 13- and 52-week basis.
The Growth index has still outperformed on a rolling 52-week basis, but the spread has shrunk. This is by no means evidence of a prescient call. The previous post mentioned the then-current spread had been above one standard deviation for 18 weeks, below the average of 24 weeks of the previous high-growth regimes. It finally dropped below the one standard deviation level in September, lasting 45 weeks (counting from the first breakthrough to the final, as there were a few weeks that ended below one standard deviation – 39 weeks ended above in the period). This most-recent regime ended up being the second-longest since the end of the tech bubble (07/20/07 to 07/04/08 lasted 51 weeks from beginning to end, with 38 weeks above the one standard deviation line).
What does this mean going forward? The recent narrowing of the growth spread does not guarantee future outperformance for value. It would be futile to extrapolate recent moves, especially over the near-term. Over a longer period, the pattern could be expected to take shape in a similar fashion to the last sixteen years. When the growth-value spread is stretched it is easy to think it will revert soon, but in reality, the above-average differential can last longer than might be expected. It is easier to spot long-term trends in hindsight, than to predict even the next few months. Even with the belief that behaviors are predictable, and trends often mean-revert, correctly timing those changes can be challenging. However, if done successfully, an active manager can benefit from that insight.
It might be deceptive to think this means there are currently no opportunities to find value in individual securities. In general, value, tends to be better positioned at the bottom of an economic cycle when fear and uncertainty are high, while growth is bid up towards the end as investors ride the momentum of continually rising expectations. However, value does not always mean the lowest measure on some ratio. Value is determined based on price relative to expected cash flows. If growth prospects are strong, there may be value in higher growth companies that have mispriced expectations.
With a strong economy, low volatility, and an accommodative Federal Reserve, it is hard to determine when things may change…but they always do.
To read more about the market conditions currently facing active managers, read our first quarter Wall Street Mood Monitor >