By Philip van Doorn, MarketWatch
Value stocks, which have been overshadowed by growth stocks including Amazon, Alphabet and Netflix, may make a comeback beginning this year as investors flock to defensive investments.
That’s according to Justin Tugman, a portfolio manager at Perkins Investment Management in Chicago. Tugman said value stocks outperformed growth stocks for 15 straight quarters in 2002-2006 during the last period of sustained increases in interest rates by the Federal Reserve.
There’s an age-old argument between money managers who favor growth or value strategies, and it appears the market is ready for value to shine after nine years of growth dominating the stock market. A combination of higher interest rates and faster inflation bodes well for value strategies, and a potential trade war would only add fuel to the fire, according to Tugman, a value-portfolio manager at Perkins, a subsidiary of Janus Henderson.
Growth as bull-market winner
First, take a look at this chart comparing total returns of the Russell 1000 Growth Index /zigman2/quotes/210598136/delayed RLG -1.10% and the Russell 1000 Value Index /zigman2/quotes/210598148/delayed RLV -0.55% from the U.S. stock market’s bottom on March 9, 2009, through the first quarter of 2018:
The growth index includes the components of Russell 1000 Index with higher price-to-book ratios and faster expected earnings growth rates, while the value index includes the components with lower price-to-book ratios and slower earnings growth rates.
Growth has been the better strategy in the bull market, which may have recently ended. And the bull market has been greatly supported by the stimulative policies of the Federal Reserve and other central banks, which increased the money supply and kept interest rates at historically low levels for nearly a decade.
But Tugman, who co-manages the $2.8 billion Janus Henderson Small-Cap Value Fund /zigman2/quotes/202209233/realtime JDSAX -0.17% and the $3.8 billion Janus Henderson Mid-Cap Value Fund /zigman2/quotes/201164166/realtime JMVAX -0.85% said the stage is set for a reversal because central bankers are moving to “a more normalized environment” of higher interest rates.
A potential trade war with China would be “more of an inflation activity than anything else,” because prices would automatically rise, Tugman said in an interview April 1. “This will probably push the central bankers to be a little more aggressive with their posture on interest rates,” he said, while also pointing out that higher labor costs were also pushing prices higher.
Higher interest rates
Check out this 20-year chart comparing total returns for the Russell Growth and Value indexes:
The performance of the growth and value groups runs in cycles, and for 20 years through the first quarter of 2018, value has come out on top, even with the growth group’s runaway success over recent years.
“The longest period of outperformance of value versus growth was 15 quarters, 2002 to 2006, when the Fed was raising interest rates,” Tugman said. Starting in January 2001, when the Fed lowered the target for the federal funds rate to 6% from 6.5%, the central bank continued chopping rates until June 2002, when the target federal funds rate was set at 1%. Then the rate was lifted to 1.25% in June 2003, and the increases continued until the target rate hit 5.25% in June 2006.
Here’s the chart showing how the Russell 1000 Growth and Value indexes performed from the end of 2000 through June 2006:
The value approach did its job as a defensive play during the last cycle of rising interest rates. This time around, inflationary pressure brought about by rising rates as demand for workers increases could force the Fed to be more aggressive. It’s too early to say how far the trade-war saber-rattling between President Trump and China will go, but if you fear a trade war, you also fear inflation.
Investing for value
Tugman joined Perkins Investment Management in 2004 and became a portfolio manager for the Janus Henderson Small-Cap Value Fund in 2009. He joined the management team of the Janus Henderson Mid-Cap Value Fund in 2015.