Does the current environment favor Growth or Value?
Growth stocks are composed of steady high earnings growth industries like Information Technology and Pharmaceuticals (including biotech) while Value stocks are made up of more traditional industries like Financials and Industrials whose earnings grow slower and are more vulnerable to economic downturns. Not surprisingly, Growth tends to have higher valuations than Value as measured by the ratio of share price to trend earnings or P/E – with current P/Es of 27 and 22, respectively. During the 1990s Growth beat Value until the collapse of technology in 2000 while Value beat Growth in the early 2000s until the financial collapse in 2008. More generally, declining treasury yields have over the last 25 years been a tailwind for Growth whose higher expected earnings farther down the road make its valuation more sensitive to the rate at which they are discounted.
The current economic and financial instability implies greater cyclical earnings risk and thus favors Growth over Value. Longer term, however, an end to secular declines in Treasury yields may not currently be reflected in relatively high Growth valuations suggesting greater price vulnerability going forward. (See our previous features – Sector Dynamics and Mispricing Risk).
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