Style Rotation - September 2019

Updated: Oct 8, 2019

Style Rotation


Growth stocks have out-performed value stocks since the Global Financial Crisis ("GFC"). By some measures, growth has out-performed value for well over a decade. The out-performance of growth stocks is consistent with an environment typified by:

  • Low and falling interest rates

  • Slower economic growth

  • A banking industry that's more regulated, runs with less leverage and has tighter margins due to low interest rates (financials stocks are heavily represented in most value strategies and indices)

  • The rise of large, technologically sophisticated and highly profitable platforms businesses (e.g. the FAANGs)

These conditions remain in place. And it looks likely to me that they'll continue (that's my base case). So, I'm not ready to call an end to the multi-year trend of growth beating value just yet. 


Still, growth stocks carry the risk of short-to-medium term under-performance. Their fantastic multi-year run has resulted in many growth stocks now trading at expensive levels. It is likely that these stocks will be susceptible to profit taking and shifts in investor sentiment.


While it's likely that growth with do well given current condition, it's very unlikely that growth will have it all its own way. The current growth-versus-value performance cycle has seen several short-to-medium term periods where value has out-performed growth. These periods have lasted for a year or more. They start with a violent move from growth to value. 


Please note: All charts and figures below are shown in USD.

The top panel in the chart above shows the ratio of the daily performance of the SPDRS S&P 500 Growth ETF vs the  SPDRS S&P 500 Value ETF ("growth:value ratio") during August and September 2019. The vertical bars show the intra-day range, while the smaller horizontal bars mark the end-of-day ratio. Rising horizontal bars mean that is growth out-performing value. Falling horizontal bars mean that value is out-performing growth.


Starting on 28/8, value beat growth for ten consecutive trading days (blue arrow). Of the 23 trading days from 27/8 to 30/9, value has beaten growth on 17 days, or 74% of the time. 


It's important to remember that we're now looking at this with the benefit of hindsight. For example, on 1/9, value had beaten growth for four consecutive days. This has happened several times over the last year. At the time, the most likely explanation was profit-taking, i.e. selling some of the growth stocks that had done very well over the last twelve months. It was only a few days later that the the magnitude of the move indicated that something else might be happening. 


As the chart below shows, growth went from being approximately 2% ahead of value (from 28/9/2018 to 27/8/2019) to approximately -2.25% behind over the last twelve months. That's a swing of approximately 4.25% in a little over one month. This is the kind of big move that's worth paying attention to. 

On September 13, the 20-day (i.e. roughly one month) standard deviation of the growth:value ratio crossed 15%. Big spikes in the volatility of the growth:value ratio happen infrequently. They have occurred only five times since the GFC.

The three panels of the chart above (from top to bottom) show:


1. The growth: value ratio (price)

2. The cumulative performance of growth vs value in percentage terms

3. The rolling 20-day standard deviation of the growth: value ratio


i've marked the five post-GFC spikes in the standard deviation of the growth:value ratio on the chart (dotted blue lines). In each case, growth has either been flat vs value (April 2009 to April 2011) or under-performed (January 2016 to May 2017).


You've probably noticed that the pre-2009 spikes in the standard deviation of the growth:value ratio on the chart we followed by periods where growth beat value. This was due to the severe under-performance of financial stocks (the largest sector in most value indices) during the GFC.


What caused this rotation from growth to value? It's impossible to say for sure, although sudden large increases in long-term interest rates (highlighted in blue) are a likely candidate. The chart below shows the 10-year US Treasury yield over the last five years. 


There was also a smaller rotation between small cap and large cap stocks. The chart below shows the performance of the SPDRS S&P 500 ETF (large cap) vs the iShares Russell 2000 ETF (small cap). A falling line (blue) means that small caps are under-performing large caps. Small caps were behind by roughly -14% in the eleven months to the end of August 19. They quickly recovered approximately 4% of this under-performance before giving it back.


Will this style rotation persist? I'm not sure. Episodes such as this underscore the importance of diversification and risk management across multiple dimensions, including style. I believe that we're still in an environment that favours quality and growth stocks. But my conviction in this belief is not as strong as it was at the end of August. Consequently, I increased the allocation to value during September (see below).


The style rotations from growth to value and from large to small were one of the reasons why both Best Ideas strategies under-performed in September. Currency and the performance of a few stocks were also culprits. . The good news is that both Competitive Edge ("CE") and Market Timing ("MT") begun September with a 23% allocation to value. Here's CE:



And here's MT:



The bad news is that we didn't have enough invested in value stocks to compensate for the under-performance on some of the growth and quality stocks. I write this with the benefit of 20:20 hindsight.

But I did take action On 10/9, I increased the allocation to value by purchasing the SPDRS S&P 500 Value ETF (SPYV). Shortly afterwards, I also added a position to small stocks by purchasing the iShares Russell 2000 (IWM) ETF. 


The portfolio may increase its allocation to value stocks in October. I am likely to do this by selecting additional names from the Value list and/or reducing the allocation to SPYV and IWM. As always, the shifts will be gradual if and when additional evidence of a style rotation emerges.

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