Written by: Craig Adeyanju
A new trend has unfolded in the stock market over the past month. Value stocks have been outperforming growth stocks. The Russell 1000 Value Index (RLV) has risen over 7% in the past month versus just over 3.9% for the Russell 1000 Growth Index.
According to analysts, the new trend is being driven by Wall Street's concerns regarding the long-drawn trade dispute between the United States and China as well as uncertainties around the future of the Federal Reserve's interest rate policy. At its core, the new value-growth trend underlines the fear that a recession might be imminent
and if that's the case, investors might want to hop on the value trend. Here's why.
Value Stocks Outperform Growth Stocks in Economic Uncertainties
To understand why value stocks tend to perform better than growth stocks in recession, one needs to look at the main difference between the two names.
Value investors generally look back to the past, while growth investors look to the future. Here's how that works. Value hunters typically analyze financial statements to determine the intrinsic value of a stock and compare it to the stock's current price. Stocks with intrinsic values lower than their current prices are generally considered value stocks.
Growth hunters, on the other hand, hypothesize that a stock will offer above-average returns if the underlying company grows at above-average rates. So stocks are regarded as growth plays when there are opportunities for above-average growth rates mainly in revenue, earnings and cash-flow.
Since recessions are underlined by a regressing economic situation, it becomes difficult for investors to see how companies can achieve growth when the entire economy is struggling. This situation typically drives investors to value stocks, whose underlying businesses might have successfully weathered a series of economic boom and bust.
The dotcom crash, during which growth stocks lost significantly more than value stocks, is a good place to see this trend play out. As shown in the chart below, value stocks fared better than their growth counterparts during the dotcom crash.
This trend didn't hold during the 2008 recession, and understandably so, because the recession was a result of poor decisions in the financial industry, which dominates many value stock indexes. And the present economic uncertainties bear more resemblance with the dotcom bubble era than the 2008 recession. That is because the U.S.-China trade disputes have little to nothing to do with poor decision making in any sector, except, of course, the governments. While this shouldn't affect growth stocks directly, the aforementioned skittishness of investors toward growth in economic uncertainties play out against growth stocks.
Related: A History Lesson For Pundits Who Don’t Believe Stocks Are Overvalued