Following another year in which U.S. growth stocks have extended their unusual cycle of outperformance over U.S. value stocks in terms of both duration and magnitude, investors may be wondering if something has radically changed. Historically, over long periods of time, value stocks have outperformed growth stocks by a substantial margin. However, that has not been the case for more than 13 years as of December 2019, the longest period of growth dominance on record.
After such cycles of extreme underperformance, there usually has been a sharp and sudden reversion to outperformance by value. But now, with technological change and disruption having driven growth stock performance for so long - forces showing few signs of abating - does that mean the historical cycle of mean reversion is dead or dampened?
Value changed, not destroyed
While the tech disruption has driven many growth stocks higher,
it has generally collapsed the profit margins of many value stocks, made them very cheap, and posed heightened existential risks for some. That means that investors shouldn't just wade into value stocks and buy companies based on their potential for mean reversion alone, McPherson says.
"You have to be even more thoughtful about value stock investing than in the past," she says. "Eventually the growth‐value performance cycle will turn, but you have to really do the necessary research to understand the fundamentals of value stocks and their competitive threats."
While disruption has made value investing much more difficult, McPherson says, the classic value investing model has not fundamentally changed.
Sudden reversals of fortune
Given growth stocks' extended period of outperformance, it may be tempting to consider aggressive moves into and out of growth and value. However, this can be a costly strategy as changes in style leadership and relative performance can happen very quickly. As shown in the chart below, being just one month late in the reversal from growth to value cycles in the last 10 transitions, dating back to 1929, could have cost investors an average of 13% missed outperformance, and being a quarter late could have cost an average of 28%.
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