Will 2021 be the Comeback Year for Value Stocks?

Over the last 10 years (through 2020), Growth stocks have returned about 17% annually while their Value cousins have turned in an annualized performance of about 10%. Strong performance by both styles for sure, but Growth has been the winner.

But when you dig a little deeper into these numbers, you find that a significant portion of the outperformance by Growth has largely stemmed from technology stocks. In fact, in some years, the gains in just a handful of big cap tech stocks like Apple, Amazon, Google and Microsoft account for nearly half of all the returns in the Growth sector.

While the past decade has ushered in strong sales, rising user growth and outsized stock gains for some tech companies, it has also led to stock prices that are increasingly disconnected from underlying earnings. Today there are a record number of companies with zero or even negative earnings and many of them are tech companies trading at very high prices relative to those earnings.

The difference between the price to earnings ratio (P/E) of Growth style stocks and the P/E of Value style stocks is the widest it’s been since the tech stock bubble of 2000. Will the valuation spread become even wider in 2021? It’s possible for sure, but it’s also possible we see a reversion as investors begin to rotate away from the high P/E tech names and look for more opportunities in Value.

Mean reversion isn’t the only possible factor in favor of a rotation to Value in 2021. Over the last 12 months, the government and Federal Reserve have taken extraordinary measures to sustain the economy during the COVID-19 pandemic. In addition to the liquidity injected into the financial system by the Fed, government stimulus has taken the form of direct transfers such as stimulus payments to American families and “PPP” and “Main Street” lending to businesses. The result of all this is there is an enormous amount of liquidity in the financial system, which historically has been a precursor to higher inflation.

Rising inflation levels tend to push interest rates higher, which weighs on stock valuations, especially growth stocks. There are several reasons for this: Higher rates provide improved returns to bond investors, but also open the door for assets that were allocated to equities to be re-directed into income securities. Higher rates also negatively impact valuation models that use the U.S. Treasury market as the proxy for a “risk-free return” benchmark to justify equity valuation premiums. The higher the risk-free return, the lower the equity premium must be. Alternatively, rising rates tend to favorably impact some value sectors – like financials – that could see increased investor interest as their profitability improves.

It is still early days in 2021 and there could be many factors that may impact the equity market performance beyond what we’ve discussed here, but there appears at least to be the potential for the value style of investment to have its day in the Sun.

About the Author

Randy Beeman has more than 15 years of experience managing financial assets for individuals, retirement plans and businesses. Randy joined YHB | Wealth Advisors in January of 2018 and serves as the Director of Wealth Management. He was a co-founder of the Wise Investor Group in Reston, Virginia and co-hosted The Wise Investor Show on WMAL 630 AM and 105.9 FM in Washington, D.C., and the Midweek Update podcast heard on iTunes. Randy was named to the list of Barron’s “Top 100 Financial Advisors” in the United States each year from 2009 to 2013. He is the co-author of Value Returns: Wise Investing for the Next Decade and Beyond.