If all a client does is look at large-cap stocks, she'd be apt to think that growth stocks are doing pretty well this year even with all the hoopla surrounding value equities.
Indeed, growth stocks are performing well. In fact, that segment is narrowly beating value. The S&P 500 Growth Index is up 17.9% year-to-date, as of Oct. 13, while the S&P 500 Value Index is higher by 17.1%. That doesn't necessarily jibe with all the attention being bestowed upon value stocks in 2021, but large value may have its moment again if 10-year Treasury yields continue rising.
Moving on from large stocks, some smaller equities are turning in decent performances this year and that's encouraging for fans of cyclical assets. Smaller stocks are also where the value/growth gap is too large to ignore. Year-to-date, the Russell 2000 Value Index is up a scintillating 25.7% while the Russell 2000 Growth Index is up just 4%.
So small-cap growth is lagging not only large-cap growth, but small-cap value, too. That's practically enough for any client to want to eschew the volatility associated with smaller growth and remain in greener pastures. Advisors know better and they can help long-term minded investors discover opportunity amid the current small-cap growth malaise.
Dislocation and Rates
Given the aforementioned gap between the Russell 2000 growth and value indexes, “dislocation” is an accurate way of describing the current state of affairs among small growth and value names. However, some clients may be concerned that rising interest rates could dent the case for smaller secular growth fare. The concern is relevant, but it may prove unwarranted.
“The dislocation between what we believe are comparably strong fundamentals and returns remains wide, and there has been an almost 20% performance gap between small growth and small value (measured by the Russell 2000 Value Index) year-to-date through mid-September,” says Brian Jacobs of VictoryCapital. “This drives our view that small growth as an asset class appears attractive, and we continue to see strong underlying fundamentals in many small secular growth stocks. Importantly, our work also suggests that small-cap growth investors need not be anxious in the face of rising rates.”
Part of the reason small-cap growth is scuffling this year is that it's usually light on cyclical sectors, meaning basic benchmarks like the Russell 2000 Growth aren't intimately levered to the reopening trade.
“This leadership change within the Russell 2000 Growth Index has been especially pronounced as the sectors that had lagged during the start of the pandemic have more recently driven the market higher, including consumer discretionary, producer durables, energy, and materials processing sectors,” adds Jacobs. “Meanwhile secular-oriented sectors, including health care and technology where many disruptive companies with long-term growth potential operate, have lagged.”
The Russell 2000 Growth allocates more than half its weight to healthcare and tech names while industrials, energy, materials and consumer cyclicals combine for about 34%.
Growth at a Reasonable Price?
Beyond volatility and strong return prospects, if there's one thing advisors know about small-cap growth it's that this style is rarely inexpensive. In fact, it's frequently (nearly always) richly valued.
That's not the case today. Something worth passing along to clients is that small-cap growth isn't just inexpensive relative to the large-cap equivalent, it's trading at a notable discount to small-cap value.
“For context, consider that the forward P/E ratio of small growth companies (excluding those companies that do not yet have earnings) stands at more than a 25% discount relative to those large-cap companies in the Russell 1000 Growth Index,” concludes Jacobs. “That is even more intriguing given that historically (over the past 20 years), investors would have to pay a slight premium on average to capture the exciting potential of small-cap growth companies.”
Related: Don't Toss Tech Even If Rates Rise