2023-06-22 21:20:00 ET
Summary
- After the global financial crisis of 2008/09, U.S. equities - particularly growth-oriented U.S. equities - went on a run.
- For an extended period in 2022, it started looking like the growth rally was over and the value cycle had begun.
- Periods of growth or value outperformance and underperformance tend to unfold over years.
By Christopher Gannatti, CFA
After the global financial crisis of 2008/09, U.S. equities - particularly growth-oriented U.S. equities - went on a run. For an extended period in 2022, it started looking like the growth rally was over and the value cycle had begun.
Periods of growth or value outperformance and underperformance tend to unfold over years. It would be rare for investors to look at long-term charts and see quick shifts in value/growth leadership. If history is a guide, we can think of two logical scenarios now unfolding:
- Scenario 1: 2022 was a blip and the growth rally is really just continuing. The world’s largest tech companies are pushing markets higher and value is relegated to underperformance.
- Scenario 2: The first half of 2023 is the blip and the value rotation that many investors caught onto in 2022 will pick back up after this shorter period of growth outperformance.
In this piece, we focus on those who believe that the value rotation is coming back, that is, Scenario 2. We noted in a prior blog post that something ‘weird’ is happening in the relationship between the S&P 500 and S&P 500 Value indexes, and we extend some of that analysis here.
Analytical Framework: Funds & Indexes
Within this piece, we reference:
- iShares Core S&P 500 ETF ( IVV ), which tracks the returns, after fees and expenses, of the S&P 500 Index.
- iShares S&P 500 Value ETF ( IVE ), which tracks the returns, after fees and expenses, of the S&P 500 Value Index.
- WisdomTree U.S. LargeCap Dividend Fund ( DLN ), which tracks the returns, after fees and expenses, of the WisdomTree U.S. LargeCap Dividend Index
- WisdomTree U.S. High Dividend Fund ( DHS ), which track the returns, after fees and expenses, of the WisdomTree U.S. High Dividend Index.
The critical discussion relates IVE, DLN and DHS - all strategies having varying degrees of value-type exposure - back to IVV in terms of performance and valuation.
As we saw in a prior post, if Microsoft ( MSFT ) is the top holding of the S&P 500 Value Index by a significant margin (and also of IVE), it has implications for the relative discounts and ‘true’ value tilt - which can be in the eye of the ‘beholder’ or index methodology.
The Setup: Performance in the First Half of 2023
First, we show the year-to-date performance in 2023.
- IVV returned nearly 12% - from a narrow subset of large, tech-oriented companies that includes Microsoft.
- IVE returned greater than 8% over the same period, driven by top 10 exposures to Microsoft, Meta Platforms ( META ) and Amazon.com ( AMZN ). We also note that the tenth position in IVE was actually Netflix ( NFLX ), not a company normally at the tip of a value investor’s tongue.
- DLN was up 1.18% over the period, whereas DHS was down 5.17%.
- If a small subset of large tech companies is going to lead the U.S. equity market, DLN may be able to catch Apple ( AAPL ) and Microsoft - payers of significant dividends - but DHS is unlikely to catch the major tech ‘growth’ companies, due to the nature of its Index focusing only on higher yielding dividend-payers.
Figure 1a: Standardized Performance as of March 31, 2023
Figure 1b: Zooming in on Year-to-Date 2023 Performance
‘Value’ Is Usually Defined by Fundamental Metrics
The price-to-earnings (P/E) ratio is likely the most widely followed of the different metrics used to denote whether a stock, index or fund is expensive or inexpensive.
IVV, IVE, DLN and DHS all contain large, established, profitable companies - for the most part - so it is appropriate to look at P/E multiples. Figure 2 shows:
- None of the strategies is ‘most expensive’ or ‘least expensive’ on a P/E basis for the full time series.
- From late-2021 to early-2022, DHS’s P/E ratio was quite clearly declining, and it is getting close to single-digit territory at present.
- IVE’s P/E ratio has increased significantly from late-2022. We know that the S&P 500 Value Index (tracked by IVE) went through a reconstitution that was responsible for getting companies like Microsoft, Amazon.com, Meta Platforms, Salesforce ( CRM ), Cisco ( CSCO ) and Netflix into the top 10 holdings. IVE’s P/E ratio is looking very similar to that of IVV, the Fund that tracks the return of the broader S&P 500 Index.
Key Question: If an investor is looking for value, does it make sense to search for it in a strategy with a similar P/E ratio to the broad benchmark?
Figure 2: Divergence in Price-to-Earnings (P/E) Ratios among Value-Oriented Funds
For further details see:
To Capture A Value Rotation Make Sure You Have Value Exposure