The year 2015 has thrown a few punches to investors. Through the end of August, the U.S. markets are down 2.56% and foreign markets are down even more. In the United States, almost every asset class is in the red, except for growth stocks.
Morningstar uses a 3 x 3 box to report on the average returns of all companies in a particular style. You can see from the chart that Small Value stocks performed the worst (-7.34%) and Large Cap Growth the best (+2.79%). However, all of the gains have come in the Growth sectors so far this year with Small Cap, Mid Cap and Large Cap all up a bit through August.
This years’ result goes against the long-term trend where we’ve seen value stocks outperform growth stocks by nearly 5% on average. When looking at market data that goes back to 1927, we see a strong trend in favor of value stocks.
On the other hand (and we all know Mr. Market has an unusual number of hands), this years’ performance has been more probable than not by one account. We come to this conclusion by viewing another dimension, the forward P/E ratios relative to historical averages.
Historically, market participants are willing to pay on average 45% more for $1 of predicted earnings from a growth company than for earnings from a value company. They do this for a variety of economic and behavioral reasons, which is what causes the lower average annual returns for growth stocks. Value stocks usually look like a bargain, but the odds have favored growth stocks for over a year.
Throughout this year the growth premium has fluctuated between 25% – 29% which doesn’t exactly sound like a cannot-miss deal. But when you factor in the history growth companies have in rapidly growing their earnings power, a lower premium raises the likelihood of growth stock outperformance which is why we’ve reduced our normal allocation to value stocks to make room for more growth.
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