Growth vs. Value

Part of our daily research includes reviewing financial news that may impact our firm’s investment strategy. We recently came across an interesting article discussing the current disparity in relative valuation of growth stocks compared with value stocks (the link to the article can be found below). “Value” stocks are generally considered to be lower P/E, lower growth, higher-dividend paying stocks, while “growth” stocks are generally considered to be higher P/E, faster-growing companies that pay little or no dividend. The article notes that valuations for growth stocks are now quite low relative to historic relationship to value stocks (this is also supported by work from some of our other research sources).

So what’s the big deal about the valuation disparity of growth vs. value? Answer: the disparity may provide a strategic investment opportunity in favor of growth. Over the past several years, many investors have been favoring high-dividend, primarily large-cap stocks for obvious reasons: fear of volatility associated with smaller-cap stocks; an alternative to declining bond yields for those seeking income; reduced risk tolerance on the part of many investors. This has resulted in compression in valuations for growth relative to value and, hence, has led to the valuation disparity.

From a financial planning perspective, we advocate a diversified portfolio approach; we can and do adjust our allocations to growth and value based on relative valuations and relative performance; and we also seek the higher risk-adjusted returns. As an example of this, we recently changed our mid-cap equity exposure in favor of growth vs. value in order to capture what we believed is a valuation disparity noted above. Because mid-cap stocks are larger in market cap and, as a group, pay higher dividends than small cap stocks, favoring mid-cap stocks over small caps offers the benefit of both higher portfolio income and reduced portfolio volatility. At the same time, holding a diversified index of mid-cap growth stocks as part of a larger, well-diversified portfolio helps our clients achieve their long-term goals by capturing the return of this sector (which has significantly outperformed the S&P500 over the past 5 years) and thereby targeting a superior risk-adjusted return.

Link to article: http://finance.yahoo.com/video/sponsored-26302475/growth-stocks-are-a-coiled-spring-says-nuveen-s-mullinix-30110011.html#crsl=%252Fvideo%252Fsponsored-26302475%252Fgrowth-stocks-are-a-coiled-spring-says-nuveen-s-mullinix-30110011.html

How Long ?

There has been a lot of talk in the financial media lately about the notion that stocks may be in an “extended trading range” like that of the 1970s. What that means is the market remains essentially flat for an extended period, perhaps a couple of years or longer, while churning up and down within a wide price range. The case for this view is based on the belief in an extended period of very slow economic growth (or no growth) which results in very slow or no growth in corporate earnings.

One big question being asked now is “how long will this trading range environment last”? It is interesting to note that the market, as measured by the S&P500, has more than doubled since March 2009 bear market low. It has done this in three waves accompanied by some rather unnerving corrections. Corrections are normal for the stock market: the median decline for the stock market in any given year over the past 85 years has been about 13.5%. So pullbacks of 5, 10, or 15% are quite normal and do not mean we are in a “trading range”.

There are a number of reasons to believe the “extended trading range” scenario may be too pessimistic. First, we think there will be tremendous pressure on Congress and the President (whoever that is) to take action in 2013 to address the fiscal cliff issue and place the U.S. on a stronger footing financially. We also expect improved clarity on government policy particularly with respect to health care. These actions would provide companies more confidence in forward planning which should improve the pace of hiring in the U.S. Also, the current financial health of large U.S. companies is a factor working in the economy’s favor because of their ample resources available to accelerate investments and hiring under the right conditions.

Whatever your view on the extended trading range question, the strategy should not change from a financial planning perspective. We believe the current environment still calls for investing in diversified, balanced portfolios of high quality stocks and bonds, favoring equities now, and with adequate geographic diversification to capture faster growth of markets outside the U.S. We would also emphasize the importance of sticking with a sound financial plan. While markets will fluctuate as they always do, sticking with a sound plan will 1) keep you on track relative to your investments; 2) help keep you from the temptation of trying to time the market or make emotionally-based decisions that can sink a plan and an investment portfolio; and 3) provide the peace of mind of knowing you have a roadmap which reduces guesswork, conjecture, and flip-flopping on your investment strategy, all of which adds unnecessary stress to your life.