adminWhat does that say about growth stocks?
For the past 11 years’ value has underperformed growth as a style. This is the longest such period in history.
As illustrated by the chart, there have been four times in which growth has strongly outperformed. All four have corresponded with the US Federal Reserve intervening aggressively in the interest rate market.
In the most recent period, quantitative easing has created enormous liquidity that has supported equity prices. This is most obviously reflected in the huge gains made by large technology stocks. As the chart below indicates, this has led to a growing concentration in the Russell 1000 Growth Index, which is generally considered the benchmark for the growth style in the US. The top 10 stocks now make up almost 35 percent of the index, a level last seen during the dotcom bubble.
“What’s really happened over the last 11 years is that tech stocks have done exceptionally well,” ex-plains David Pyle, co-portfolio manager of the Large Cap Value Fund at Boston Partners.
“Not every stock that has growth characteristics has done well, and value stocks haven’t done poorly. It’s just that tech has done exceptionally well.”
Growth and attrition
This handful of stocks has grown enormously influential, not just for growth investing, but across the market. Information technology now makes up 21,7 percent of the S&P 500 Index, and more than 15 percent of that is in just five companies — Microsoft, Apple, Amazon, Facebook and Alphabet.
This might feel like a systemic change, since the market now looks quite different to how it did just 15 years ago, but it is less of an aberration when one looks at it in historical context. Back in 1960 just one stock alone — AT&T — made up over 10 percent of the S&P 500.
There is, however, an enormously high attrition rate for stocks in the top 10 of the S&P 500. As the graph illustrates, companies frequently move in and out of these positions.
While it seems confusing at first glance, what it is showing is the weightings of the top 10 stocks within the S&P 500. Each line represents a company, and the different colours show in which decade they entered the top 10.
“The first point this makes is that today’s winners are not necessarily tomorrow’s winners,” says Pyle.
“Things change over time.”
The second point it illustrates is more subtle.
“You should never forget that underlying any index is a set of stocks,” says Pyle.
“Especially with ETFs (exchange-traded funds), people disconnect themselves from the fact that they are buying a set of fundamentals and characterises. And as these indices become more concentrated, they are concentrating their investment more in certain sectors.”
The lone survivor
It is significant that almost all of the large stocks illustrated in the graph above have, over time, under-performed. This can be seen by the fact that very few of them have maintained their positions in the top 10. Only one that held this position in the 1960s is still there today, and that is ExxonMobil.
It is also evident how there are periods where a number of companies came into the top 10 but fell out again fairly soon thereafter. This happened both in the 1980s (the bright yellow lines) and the 1990s (the green lines).
In the 1980s this was the rise of oil and gas companies following the impact of the 1970s oil embargo. The spike in oil prices this induced made energy companies the growth stocks of the day. The 1990s saw a surge in consumer stocks like Coca-Cola.
“That is fairly typical of growth,” says Pyle.
“Something becomes interesting for whatever reason and that is reflected in share prices. We had energy companies in the 70s and 80s, caused by a political event, and then we had consumerism in the 80s and 90s. Now we have technology. These companies can stay there for a while but eventually capitalism works, companies compete and they compete away the returns.”
But is this time different?
The historical pattern is quite clear. However, many investors will argue that the rise of tech companies today is different. They believe businesses like Facebook, Google and Amazon have irreplaceable plat-forms, making them immune from competition.
However, Pyle is more pragmatic.
“They said that about IBM too,” he points out. “It was the third largest company in the index in the 1960s, and now it’s gone.”
While it’s true that the large tech companies have substantial competitive moats, other businesses have had similar advantages in the past, such as US Steel and AT&T. These moats do not last forever.
“Things change,” says Pyle.
“That’s capitalism. They change because of something new coming along — a competitive threat or regulation.”
The latter may be the more likely to impact on the current tech leaders. This is because when large companies gather too much influence, governments tend to act to moderate that power.
“IBM was put under scrutiny by the government,” Pyle points out.
“AT&T was broken up the government. These things happen. And what do you hear now? The European Union and the US are casting a wary eye towards Google and Facebook.”
That doesn’t mean these aren’t good businesses, not does it mean it doesn’t make sense to own them if the valuation is appropriate. Investors should, however, be careful about extrapolating their recent growth into a limitless future.
“These things don’t last forever,” Pyle says.
“That doesn’t mean that they can’t last for a while, and it doesn’t mean that they can’t generate good returns.
“We own Alphabet in our fund. But will it last forever? Probably not.” — Moneyweb.
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