Many investors have been firmly overweight growth over the last 18 months. Until this month, this has been fruitful as growth outperformed value by almost 15% during that time. While we remain cognizant of the fact that absolute returns remain on the forefront for most investors at this time; more recently, growth has outperformed value by almost 8% during the recent selloff that brought about the fastest-ever bear market.
Even with the recent end of the 11-year bull market due to the evolving situation regarding the coronavirus, investors may not be ready to rotate away from growth. So, would change this? In short, the data will guide us. In other words, we believe that we need to see the start of a new economic cycle in order to overweight value.
What We’ve Seen
On March 15, along with cutting the federal funds rate to the lower bound, the Federal Reserve announced that they would begin another asset purchasing program better known as quantitative easing (QE4). This time around, they planned to purchase $500 billion of Treasuries and $200 billion of Mortgage Backed Securities until they upped the ante with the move to unlimited QE across a wider range of securities including investment grade corporate ETFs.
While this time may prove to be different, previous rounds showed growth outpacing value, and we believe that QE4 will be similar. On average, growth outpaced value by 3.05%. The outperformance of growth during periods of quantitative easing tends to be consistent with yields decreasing across the maturity spectrum and investors seeking out more potential certainty around earnings potential, which growth stocks can provide.
On the other hand, during the so-called “Operation Twist”, the Federal Reserve used the proceeds from short-term assets to purchase longer-term ones. This action lowered the yields on long-term Treasuries and supported economic growth to encourage borrowing. This forced investors to push further out on the risk spectrum, and within the stock market, those names most associated with the greatest level of skepticism around their revenue streams or balance sheet health saw substantial interest.
Due to the depth of uncertainty in today’s environment, signals are appearing to line up closer to periods of QE as investors will likely continue to hunker down with heightened levels of risk aversion. A key question this time around will be the impact that fiscal stimulus may have on steadying the economy and improving investor appetite. In addition, the Federal Reserve may implement new programs, such as yield curve control that would explicitly target a certain rate of longer-dated bonds. Most importantly, investors will need to see notable improvement in the current coronavirus crisis in order to see steps towards a return to normalcy, whether in the economy or the markets.
Previous Quantitative Easing Programs have Favored Growth
Source: Bloomberg, L.P. and FTSE Russell, as of dates noted above. Growth represented by the Russell 1000 Growth Index and Value represented by the Russell 1000 Value Index. Past performance is not indicative of future results. One cannot invest directly in an index.
Money in Motion
Even as growth continues to best value by nearly 17% over the last year, relative flows over that same period have been essentially flat. Both equity styles have seen net inflows to the tune of roughly $7 and $8, respectively. As previously noted, the recent activity tells us more about the overall lack of appetitive for investors to make relative value decisions in a market environment that is seeing a wide range of assets, including historical safe havens, suffer.
While the current market environment does make it more difficult to make notable conclusions about how, or where, the market may be overweight (and subsequently underweight), we still continue to track equity ETF flows during this drawdown. On a month-to-date basis through March 20, both growth and value ETFs have seen net outflows, but the magnitude, or lack thereof, of net outflows may surprise readers. Growth and value net redemptions of only $234M and $208M, respectively, while performance has suffered across the board. It is notable, however, that these flows are but of a fraction of some of the outflows we have seen across areas of the equity marketplace such as cyclical sectors and emerging markets.
Growth and Value Flows have been Neck and Neck
Source: Bloomberg Finance, L.P., as of March 20, 2020. Data represents the net flows of U.S.-listed U.S. Large Cap Growth ETFs and U.S. Large Cap Value ETFs, specifically targeting exposure to U.S. Large Cap Growth and Value stocks, respectively.
When the green shoots begin to emerge for the start of a new market cycle, it may finally be time for value to shine as investors will look to embrace those stocks which have been most out of favor. Of course, the challenge will be timing this, especially when it comes it comes to identifying appropriate leading indicators in a time of significant uncertainty.
A simple measure that will likely be top of mind in this case will be financial conditions broadly as they have recently deteriorated to levels last seen heading into the Global Financial Crisis (GFC). During the GFC, we did begin to see financial conditions start to improve prior to other indicators, such as jobs numbers.
Outside of having a crystal ball, investors will be eyeing valuations as well. Since the fourth quarter 2018 sell-off, stock returns have come from multiple expansion and not earnings growth. Recent weeks have seen all of this be evaporated, but neither growth nor value is at rock bottom levels, and their relative valuations do not point to either being extremely attractive. Along with valuations, earnings growth will likely surprise to the downside in the near-term and calls for a V-shaped recovery in those may be premature.
Valuations Have Collapsed, but Aren’t Necessarily Cheap Enough
Source: Bloomberg Finance, L.P., FTSE Russell, as of March 20, 2018 to March 20, 2020. Data represents the historical and relative price-to-earnings (PE) ratio of Growth represented by the Russell 1000 Growth Index, and Value represented by the Russell 1000 Value Index. The price-to-earnings ratio is a valuation measure of the price as a multiple of earnings-per-share (EPS). The left axis represents the PE ratios for each index, while the right axis represents the relative PE ratio for Growth relative to Value. Past performance is not indicative of future results. One cannot invest directly in an index.
- For those looking at the QE playbook, the Direxion Russell 1000® Growth Over Value ETF [RWGV] balances 150% long exposure to the Russell 1000® Growth Index and 50% short exposure to Russell 1000® Value Index.
- Conversely, investors interested in positioning for a value rebound, can look to the Direxion Russell 1000® Value Over Growth ETF [RWVG], which overweights value stocks relative growth stocks.
- Russell 1000® Growth Index: The Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
- Russell 1000® Value Index: The Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.
An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-301-9214 or visit our website at direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.
Direxion Relative Weight ETF Risks – Investing involves risk including possible loss of principal. The Funds’ investments in derivatives may pose risks in addition to, and greater than, those associated with directly investing in or shorting securities or other investments. Investing in, and/or having exposure to, growth and value securities involves risks. Risks of growth securities include the risk of sharp price movement, and susceptibility to increased volatility, which may cause them to perform differently than the market as a whole. Risks of value securities include the risk that their intrinsic value may never be fully realized by the market. There is no guarantee that the returns on the Funds’ long or short positions will produce high, or even positive returns and a Fund could lose money if either or both of the Fund’s long and short positions produce negative returns. Please see the summary and full prospectuses for a more complete description of these and other risks of the Funds.
Distributor: Foreside Fund Services, LLC