Value versus growth: Is it time for value?

Value versus growth: Is it time for value?

Who can argue that value investing doesn’t make sense? Buying cheap assets and selling them at a higher price is what investing is all about.

But the debate continues over value versus growth stocks. There are many ways to identify which assets are likely to rise in value and they don’t necessarily involve buying the cheapest assets.

History has shown that different styles might outperform depending on market conditions. Traditionally when bond yields fall, growth stocks have performed well, while value stocks have been known to outperform in the early stages of economic and market cycles (when bond yields rise). 

So, where are we now? I believe the decades long downtrend in bond yields (and outperformance of growth stocks) is over, which could favour value stocks.  But let’s look at history first. 

A historical perspective of value versus growth

When I started my career in the mid-1980s, it was easy to prefer assets that were selling on low valuation multiples. Back tests suggested that value investing had produced higher returns than other methods such as favouring growth.

However, things started to go wrong for value investors in the second half of the 1990s when the internet bubble drove technology and other growth stocks to unsustainable levels. Of course, the bubble eventually burst but careers were ruined among value investors who were relieved of their duties before they were proved right.

Unfortunately, the joy didn’t last, and value has underperformed growth for much of the post-global financial crisis (GFC) era. Casual observation suggests that falling bond yields were an important part of that process – in theory, the lower the prevailing bond yield, the lower the discount factor applied to future earnings/dividends and the higher the premium applied to growth (such stocks are long duration instruments, with an above average share of value contained in the distant future). As bond yields were trending lower for much of the past three decades, it should come as no surprise that growth investing has risen in popularity at the expense of value.

What's happening now?

Those working in the financial industry since the start of this century may be forgiven for believing that bond yields always fall and that growth stocks always outperform. However, we have now seen that bond yields can rise (and rise sharply) and 2022 showed that the value factor can outperform growth (and other factors). In fact, I believe that the downtrend in bond yields is now over, and I would expect something approaching normal cyclical variation.

Hence, I expect a more level playing field between growth and value than we have seen over recent decades. Some phases of the economic cycle will favour growth, and some will favour value (we find that value typically outperforms other factors at the start of an economic and market cycle).

In 2024, 10-year government bond yields rose on either side of the Atlantic, so it should come as no surprise that our value factor index has outperformed growth in both the US and Europe. Indeed, among our factor indices for the US, value has only been beaten by price momentum. In Europe, it has also been outperformed by the low volatility and quality factor indices.

However, we emphasise that value has outperformed growth (despite the continued focus on artificial intelligence (AI) related stocks). Over 2023 the strong performance of growth was explained by the emergence of AI tools, which boosted technology stocks in the US.

Even better, we expect economies to accelerate during 2025, helped by rising real incomes (as price inflation is now lower than wage inflation) and falling central bank interest rates. As mentioned above, we find that the value factor tends to perform best in the early stages of economic and market upswings.

Though we have not recently seen recession, it could be that a move to higher rates of growth could produce an “early cycle” feel. Lower central bank interest rates would normally be accompanied by lower long-term bond yields, but I suspect that will not be the case this time (due to the economic acceleration that I foresee). Hence, growth will not get the benefit of falling yields.

Value is back in business

It is my belief that equity markets have not yet fully adapted to the rise in bond yields that started in 2021/22, based on the fact that growth stocks have held up so well over recent years. Apart from the AI phenomenon, this may also reflect the fact that many investors have only worked in an environment where growth outperforms and that it may take a while for them to accept that other outcomes are possible. This could be a painful process of disappointment with growth over a number of years, as higher hurdle rates of return have their effect. In the meantime, value may perform better relative to growth than might otherwise be expected.

I don’t, however, think this will be a straight-line process. I would expect value to be strongest in the early stages of economic and market cycles and to outperform growth, in particular, when bond yields are rising (which is often in those recovery phases).

In conclusion, I am a strong believer that the major determinant of returns in a portfolio is the price paid for the assets (buy low/sell high!). Hence, I am temperamentally a value investor and believe that the decades long downtrend in bond yields is finally over, which suggests the permanent tailwind for growth stocks is a thing of the past. As growth stocks adjust to that new reality, I expect value investing to enjoy a renaissance.