Growth has been the dominant style for the U.S. equity market for pretty much all of the 2010s. Based on the S&P 500 style indices, growth beat value in every year from 2007-2020 with the exception of 2012 and 2016. That is dominance, and the cherry on top was a trouncing of growth over value in 2020 of +32.0% vs -1.4%. But in late 2020 the tide turned, and value started outperforming. All the stars were aligned for value including a sizeable valuation discount, the re-opening of the economy that would benefit value due to the constituents being more economically sensitive, rising yields and rising inflation. And it looked like the great value rotation had started… until the last few weeks cast some doubt.
Starting in mid-May, growth began to outperform, rebounding from earlier weakness. Meanwhile value appreciation stalled. Of interest, this reversal coincided with bond yields following the same pattern. After rising since last summer, the yield on the 10-year Treasury fell from 1.70% to 1.42% a week ago. There is a pretty strong correlation between changes in bond yields and the relative performance of value and growth.
The connection is logical. Bond yields tend to rise when the economic growth prospects are improving. Better economic growth benefits value companies more than growth for a few reasons. Firstly, value has greater weights in sectors that are more cyclical. Secondly, better economic growth means more companies are growing earnings; this reduces the scarcity of growth that sometimes occurs, favouring growth stocks.

Chart 2 is the 3-month percentage change in the 10-year Treasury yield and the 3-month relative performance of value vs growth. It is not a perfect relationship but the correlation is material and significant. So even though yields have come back down a bit, if you believe yields will rise in the coming months or quarters, value remains the better style tilt.
There is also no denying the valuation gap remains elevated to the extreme between value and growth. Currently, growth is trading at 27.3x and value at 17.1x forward earnings. To be fair, index valuations are market cap weighted averages of the underlying company valuations. And averages can be very misleading. For example, a person with their head in the oven and their feet in the freezer, on average should be just fine. But we know that won’t work.
A spread of 10 valuation points between value and growth is in the 98th percentile extreme based on the past twenty years (chart 3), meaning growth is very expensive compared to value. Add the yield outlook to the valuation spread, improving economic growth, improving earnings growth, inflation outlook, and these factors all favour value over growth. We believe this rotation, despite a short-term setback, is just getting started.
Time will tell if spending on travel / dining out and other activities we have not been allowed to do for the past year starts to crimp into spending on durables. Or spending on durables could normalize (aka contract from elevated levels) simply because if you bought a new sea doo or RV in 2020, you probably don’t need another new one in 2021. But so far people are simply spending freely on just about everything, and 2021 could still really surprise to the upside economically if this pace continues.
Charts are sourced to Bloomberg L.P. unless otherwise noted.
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This is not an official publication or research report of Echelon, the author is not an Echelon research analyst and this is not to be used as a solicitation in a jurisdiction where this Echelon representative is not registered. The information contained has not been approved by and are not those of Echelon, its subsidiaries, affiliates, or divisions including but not limited to Chevron Wealth Preservation Inc. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete.
Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Echelon and Richardson do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.
Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements.
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