Style Rotation in the Stock Market

Over recent weeks, the stock market has continued to rebound off the lows set back in March 2020, but a shift has occurred in what is leading the performance. Growth stocks, which have outperformed over a decade and were particularly strong in 2020, have recently been weaker compared to value stocks.  This rotation has caused a shift in recent leadership, but in our opinion has been a healthy transition.  Our belief is that a healthier market has more stocks participating in the recent rally versus the small number of growth stocks which drove a significant portion of market performance the last few years.

Below is a chart with one-year performance of the S&P 500 pure value ETF (RPV) and the S&P 500 pure growth ETF (RPG).

  • Both styles have performed well the last year with value stocks returning 61.65% and growth stocks returning 46.73%.
  • Growth stocks (yellow line) have led the way for most of the last year until the last month (green arrow) when value stocks (blue line) have outperformed.

Some of the reasons for this transition include:

  • Economic data improving at a faster rate (favoring recovery influenced stocks)
  • Rising interest rates (benefiting financials, a significant portion of the value universe)
  • Relative valuation rotation toward cheaper stocks

As the economy recovers from the effects of COVID, economically sensitive stocks stand to benefit. Further economic activity increases the demand for commodities including fuel, which in turn should boost energy stocks with employees going back to work and consumers resuming travel. Another driver of the style rotation is rising interest rates which benefit banks within the financial sector. 

As you can see in the chart below, financials (red arrow) and energy (green arrow) represent a large portion of the pure value universe while growth stocks are much more influenced by the technology sector (purple arrow). 

Regarding valuation, metrics of financial stocks are on the lower end of their historical range, unlike technology stocks which are on the higher end.   While valuation is usually not a good indicator of short-term trends, there has clearly been a rotation away from expensive technology stocks and toward relatively cheaper sectors like financials.

This transition to value has happened in short bursts many times over the last 10 years, but in most cases, growth stocks have rebounded and outperformed.  Many investors have discussed and forecasted the shift towards value stocks for the last several years, with recent trends bolstering their opinion. Inevitably, the next debate will be how long can value stocks outperform and what does this rotation mean for growth stocks.

In our opinion, investors don’t have to choose fully between one or the other.  We believe a blend of styles is the preferred approach and a diversified allocation to stocks in growth and value is a suitable method of achieving long-term returns.  We believe certain segments of growth are fundamentally strong and recent corrections have made valuation less onerous.  As a result, we will take a prudent approach to invest in stocks that can achieve high rates of growth and are now trading at more reasonable valuations.  To achieve this blend, the Gradient Core Select portfolio invests in both growth and value stocks in one portfolio, and our Tilt Series and ETF Endowment models allocate to both growth and value stocks opportunistically as well.  These portfolios all create a blended style that is diversified between growth and value but with active management to take advantage of market opportunities.