Stocks are generally split into two broad categories: growth stocks and value stocks. Growth stocks are those that tend to generate earnings (profits) consistently, regardless of broad economic cycles, because these companies sell goods and services that consumers will buy regardless of what is happening in the overall economy. Health care stocks, consumer staples stocks, and many technology stocks fit this description. For investors who are drawn to these types of stocks, the strategy is to buy high and sell higher. These stocks usually trade at high valuations and include many of the hot stocks that are often discussed in the financial press. Currently, these would include the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, Google).
Value stocks represent companies that have been overlooked by many investors. These companies may have experienced recent problems, for example, or perhaps the economic environment has just not been favorable for them. Financial stocks, energy stocks, and utilities tend to fall into this category.
Which of these stock categories leads the market has ebbed and flowed over time. Growth stocks dominated returns in the late 1990s, powered enthusiasm for the fledgling internet companies. Then, value stocks outperformed in the early 2000s as investors shunned technology stocks after the technology bubble burst. More recently, in the past 18 months, growth stocks have overtaken value stocks, rising over 40% while value stocks have advanced by only 15%. Now, once again, the rise of growth stocks has been fueled primarily by the strength of technology stocks, as well as companies like Amazon and Netflix, which aren’t officially considered as technology companies even though technological innovation is a core part of their businesses.
Given our trend following nature, FSA portfolios include several of these growth funds in the various strategies that we manage. The more conservative strategies, such as Income & Growth, have more modest allocations to growth funds, while the concentration is higher in Core Equity, Tactical Growth, and Sector Rotation portfolios.
We are now seeing hints that there is a changing of the guard in market leadership. While growth stocks have easily outpaced value stocks in 2018, the returns have been essentially the same in both categories over the past two months. In recent investor calls, both Facebook and Netflix—two of the darlings of the market these days—reported weaker earnings than expected by investors. As a result, the stocks of both companies have declined almost 20% in the past few weeks.
At FSA, we track several indicators that offer insight on the relative attractiveness of growth stocks versus value stocks. For the past 18 months, those readings have consistently suggested that growth-oriented funds were the strongest investment. In this past week, however, one of those indicators flipped in favor of value stocks.
Because our approach is to keep the portfolios aligned with the market leaders, we have been making some tweaks in many of the portfolios. At the end of the day, it makes no difference to us whether we go with growth or value stocks. Our approach is to follow the money (and of course, have an exit strategy).
Ronald Rough, CFA
Director of Portfolio Management
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