Are you Value or Growth?
Depends what we mean, I know. S&P Dow Jones says it distinguishes Value with “ratios of book value, earnings and sales to price.”
It matters because Growth is terrorizing Value. According to data from the investment arm of AllianceBernstein, Growth stocks outperformed Value stocks by 92% between 2015-2020. Morningstar says it’s the biggest maw on record, topping the 1999 chasm.
If you’re in the Growth group, you’re loving it. But realize. By S&P Dow Jones’s measures, anybody could be a Value or Growth stock at any time. It’s all in the metrics.
The larger question is why the difference? AllianceBernstein notes that the traditional explanation is earnings growth plus dividends paid. That is, if your stock is up 50% more than a peer’s, it should be because your earnings and dividends are 50% better.
If that were the case, everybody would be a great stock-picker. All you’d need do is buy stocks with the best earnings growth.
Well, turns out fundamentals accounted for just ten percentage points of the difference. The remaining 82% of the spread, as the image here from AllianceBernstein shows, was multiple-expansion. Paying more for the same thing.
Put differently, 90% of the time Growth stocks outperform Value stocks for no known reason. No wonder stock-picking is hard.
Take Vertex (VRTX) and Fortinet (FTNT), among the two very best and worst stocks of the past year. I don’t know fundamentally what separates them. One is Tech, the other Healthcare.
I do know that running supply/demand math on the two, there’s a staggering behavioral difference. FTNT spent 61 days the past year at 10.0 on our ten-point scale measuring demand called Market Structure Sentiment. It pegged the speedometer 24% of the time.
VRTX spent five days at 10.0. Two percent of the time. You need momentum in today’s stock market or you become a Value stock.
We recently shared data with a client who wondered why there was a 20-point spread to the price of a top peer. We ran the data. Engagement scores were about the same – 85% to 83%, advantage to our client. Can’t say it’s story then.
But the peer had a 20% advantage in time spent at 10.0. The behavioral patterns were momentum-style. Our client’s, GARP/Value style.
Okay, Quast. Suppose I stipulate to the validity of your measure of supply and demand, whatever it is. Doesn’t answer the question. Why do some stocks become momentum, propelling Growth to a giant advantage over Value?
I think it’s three things. I can offer at least some data, empirical or circumstantial, to support each.
Let’s call the first Herd Behavior. The explosion of Exchange Traded Funds concentrates herd behavior by using stocks as continuously stepped-up collateral for ETF shares. I’ll translate. ETFs don’t invest in stocks, per se. ETFs trade baskets of ETF shares for baskets of stocks (cash too but let’s keep it simple here). As the stocks go up in value, ETF sponsors can trade them out for ETF shares. Say those ETF shares are value funds.
The supply of Value ETF shares shrinks because there’s less interest in Value. Then the ETF sponsor asks for the same stocks back to create more Growth ETF shares.
But the taxes are washed out via this process. And more ETF shares are created. And ETFs pay no commissions on these transactions. They sidestep taxes and commissions and keep gains. It’s wholly up to traders and market-makers to see that ETF shares track the benchmark or basket.
The point? It leads to herd behavior. The process repeats. Demand for the same stuff is unremitting. We see it in creation/redemption data for ETFs from the Investment Company Institute. ETF creations and redemptions average over $500 billion monthly. Same stuff, over and over. Herd behavior.
Second, there’s Amplification. Fast Traders, firms like Infinium, GTS, Tower Research, Hudson River Trading, Quantlab, Jane Street, Two Sigma, Citadel Securities and others amplify price-moves. Momentum derives from faster price-changes, and Fast Traders feed it.
Third is Leverage with derivatives or borrowing. Almost 19% of trading volume in the S&P 500 ties to puts, calls and other forms of taking or managing risk with derivatives. Or it can be borrowed money. Or 2-3x levered ETFs. The greater the pool of money using leverage, the larger the probability of outsized moves.
Summarizing, Growth beats Value because of herd behavior, amplification of price-changes, and leverage.
By the way, we can measure these factors behind your price and volume – anybody in the US national market system.
Does that mean the Growth advantage is permanent? Well, until it isn’t. Economist Herb Stein (Ben’s dad) famously said, “If something cannot last forever, it will stop.”
And it will. I don’t know when. I do know that the turn will prompt the collapse of leverage and the vanishing of amplification. Then Growth stocks will become Value stocks.
And we’ll start again.