Why growth remains valuable

People will always prize what is scarce. Given an increasingly erratic trade dispute, low to negative interest rates and softening economic growth, investors are justifiably putting a premium on hedges, yield and earnings growth. The latter dynamic helps explains why, despite a relatively high premium, growth stocks continue to beat value. To the extent economic growth is unlikely to quickly rebound, this trend is likely to continue.

I last wrote about growth and value in early June. During the past three months, U.S. growth out-performance has continued, with growth up 7% versus less than 3% for value.

As discussed in June, growth continues to benefit from an environment of decelerating growth. For example, in June I highlighted the implications of the flattening yield curve, a trend that has only intensified. Since then other indicators have only reinforced the impression of an economic slowdown. Most recently, the U.S.’s main manufacturing gauge fell to multi-year lows, suggesting that the manufacturing sector may already be in a contraction.

Relative value elevated, not insane

The counter-argument to continued growth out-performance: a rich valuation premium. While this is a fair point, it is not the full story. Consider the following:

1. Value/growth differentials are well within their historical range.

While today’s premium of growth over value is elevated, it is not indicative of an extreme event like the tech bubble (see Chart 1). As of the end of August, the Russell 1000 Growth Index was trading at a 70% premium to value. While the current premium is high by post-crisis standards, it is not even in the same zip code as 20 years ago. At its peak in 2000, the P/E on the Russell 1000 Growth Index was 350% of the value P/E.

2. Slowing growth justifies a higher premium.

Today’s premium is about what you’d expect given the economic landscape. As I highlighted a few months ago, growth’s premium expands as economic expectations diminish. This relationship is well captured by the U.S. Treasury curve, which explains roughly 50% of the ratio in multiples. With the 10-2 Treasury Curve near inversion, i.e. 2-year yields equal to 10-year yields, today’s premium looks about right.

3. Secular trends favor growth industries.

The global economy is increasingly dominated by several secular trends: low but stable growth and inflation, the rise of the “cap-light” business model, a secular shift in consumption away from goods and towards services, and unprecedented economies of scale for select technology platforms. All these trends favor growth stocks.

Bottom line

The bottom line is not that value will never outperform again. A sharp cyclical upturn, as we experienced in late 2016, could lead to a strong period for value. That said, the tailwinds continue to favor growth, which is why investors should expect to pay a premium for it.

Russ Koesterich, CFA, is a Portfolio Manager for BlackRock’s Global Allocation Fund and is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

©2019 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

USRMH0919U-946882-1/1