Opinion: Here’s how to resolve the growth versus value debate

Since the advent of each index in 1979, the Russell 1000 Growth and Value indices have nearly identical annual returns through March 2021 – 12.1% for growth and 12.0% for value.

But the path to getting to those returns was completely different for everyone:

Value and growth alternately outperformed and underperformed depending on the cycle. Just for fun, I looked at a 50/50 portfolio of both indices, rebalanced annually. The return was 12.2% per year, higher than the performance of either of the indices taken individually. Not a great rebalancing bonus but not bad.

In the first quarter of this year, the RLV value of the Russell 1000,
+2.67%
rose 11.3% while the Russell 1000 Growth RLG,
+3.63%
was up 0.9%.

The value could be set for a stint transfer, but it’s far too early to tell. And to be fair, the cycles in the chart above are long-term in nature. There can and will be a lot of give and take in the meantime, even as we prepare for regime change.

And why couldn’t growth and worth work in the future?

To see how often this has been the case over shorter cycles, I looked at the three-year rolling annual returns of the Russell 1000 Growth and the Russell 1000 Value. I then calculated the outperformance of these annual returns, which gives us this graph:

Source: Ben Carlson


For example, in August 2020, the outperformance of annual returns of growth over value was 19.7 percentage points (24.2% to 4.5%). Even after the comeback in value in recent months, the Russell 1000 Growth has outperformed the Russell 1000 Value by nearly 12 percentage points per year over the past three years. To make up for the lost ground value would require outperforming by a total of 36 percentage points just to even things out over the last three years.

You can see most of the time that growth largely outperforms or value largely outperforms.

In fact, the three-year outperformance of annual returns is 1 percentage point or less only 16% of the time. And 26% of the time, the three-year outperformance is 2 percentage points or less. So the majority of the time one of these strategies wins and it does so with a fairly wide margin.

The last JP Morgan Guide to the Markets has a nice long-term distribution of performance and valuations by style:

With various segments of the market up 83% to 128% from March 2020 lows, it’s no surprise that valuations are high in the style box compared to 20-year averages.

So if you’re making a call on value rather than growth right now, it’s more of a relative value story as opposed to an absolute value play. Stocks aren’t cheap, but we may now live in a world where stocks aren’t so cheap for a very long time.

JP Morgan also shared a chart comparing relative valuations between growth and value:

The chart on the left is a good reminder of why we get the long-term cycles I started this article with. Value was incredibly cheap relative to growth in the late 1990s and early 2000s. Then growth became cheap as the Great Financial Crisis approached. Now the value is once again cheap relative to the growth.

Howard Marks once wrote, “In the world of investing, nothing is as reliable as cycles.”

The problem with cycles is that most people assume they will stay in their current direction forever.

The other problem is that they are very difficult to predict in terms of duration and magnitude.

Investors really have three choices when it comes to choosing between growth and value stocks:

(1) Choose a style and stick to it in hell or flood.

(2) Trying to choose which style will perform better at any given time.

(3) Own growth stocks and value stocks.

Luck plays a huge role in determining the success of option 1 depending on the length of these cycles. Option 2 sounds great until you realize how difficult market timing is. And option 3 still means holding the best performing groups of stocks, but also holding the worst performing group.

Successful investing requires a bit of luck, discipline and skill, but survival is also key. The perfect long-term strategy is worthless if you can’t stick to it in the short term.

Ben Carlson is the author of the investing blog “A wealth of common sensewhere it was first published. It is reproduced with permission. Follow him on Twitter @awealthofcs.

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