Head - Equity Strategy
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We believe a trend reversal in value vs growth is unlikely
Despite a disappointing earnings season for several tech stocks such as Facebook and Twitter, growth continued to outperform value during July (by around 0.5%).
Globally tech stocks have outperformed by 8.5% year-to-date, while consumer discretionary, the other large overweight in the growth benchmark has also beaten the broader market (by 3%). However, value’s underperformance is not just related to underweight positions in tech and consumer discretionary.
A major contributing factor has also been financials’ weak year-to-date performance.
The huge outperformance of growth over value over the past several years has invited comparisons to the late 1990s when tech stocks drove the growth/value relative to extremes.
Since October 2013, growth has outperformed value by 33% in US dollars, putting it roughly equivalent to September 1999 in the 1995-2001 comparison. From that point, growth outperformed by a further 35% over the next 6 months, before sharply reversing. If history is a guide, it is still too early to shift fully into value.
Growth valuations are less stretched this time around. A key difference between the current experience and that of the late 90s is the fact that tech’s impressive returns have been underpinned by earnings growth, rather than by speculation.
On a trailing price-to-earnings basis, growth currently trades at a 61% premium to value, which might sound high, but is still well short of the 92% premium in 2000 and should be compared to the post 1997 average premium of 38%.
Even after Facebook and Twitter disappointed, Q2 EPS growth for tech is still expected to be 24% year-on-year, while the sector continues to see positive earnings revisions over most periods (1m, 3m, 6m and 12m).
Yes, earnings revisions are slowing, but this is also true of the market as a whole.
In conclusion: The continued strength in growth indices is related to structural changes in market composition and the growing influence of technology in the economy. As long as tech sector earnings continue to underpin share price performance, a trend reversal in V/G is unlikely.
Having said so, tech sector earnings growth will slow from unsustainably high levels, this may be enough to slow the outperformance of growth indices over value, but it will not be enough to reverse it.
Looking ahead, it seems likely that the next sharp move in either direction is likely to be in favor of value. However, our preference is not to commit to one style over another, but rather to focus sector by sector on what the data is telling us. For investors with a heavy growth overweight relative to value, we recommend scaling this back over the coming 12 months.
A further consideration is the direction of the US dollar. With the Federal Reserve much further down the tightening path than other major Central Banks, Citi Private Bank believe the trade weighted US dollar will weaken over time. Growing twin deficits in the US also support this view. With tech stocks deriving over half of their revenues from overseas, a weaker dollar will support earnings.