Potential Reversal in Value Stocks vs Growth Stocks

Value stocks haven't been this cheap relative to growth stocks in over 30 years. This extreme divergence has caught the attention of some Wall Street analysts who see an opportunity amidst the disparity.

According to a team of analysts at Jefferies, growth stocks have outperformed value stocks by a ratio of two-to-one since January 1991. This margin of outperformance is the widest recorded in at least 33 years.

However, there are indications that this trend may be due for a reversal. Andrew Greenebaum, the Senior Vice President of U.S. Product Management at Jefferies, points to the share of earnings revisions as a promising signal. He notes that the difference between earnings revisions for companies in the Russell 1000 Growth Index (RLG) and the Russell 1000 Value Index (RLV) has recently favored value stocks.

This shift in earnings revisions could imply that Wall Street's expectations for growth stocks' earnings have peaked. If this holds true, value stocks could experience another period of near-term outperformance.

Greenebaum emphasizes the significance of estimate revisions in determining the trajectory of stocks. He states, "The trajectory of estimate revisions tends to be one of the most important factors influencing the trajectory of stocks. Better revisions typically means better price action."

Since the financial crisis, growth stocks have consistently outperformed value stocks, with a brief exception during the recovery period between 2011 and 2014 when value stocks had a favorable run.

While there have been exceptions, it is worth noting that they mostly occurred during periods of economic recovery from downturns, such as the global financial crisis and European debt crisis.

In conclusion, the recent divergence between value and growth stocks presents an opportunity for value investors. With the potential reversal in earnings revisions favoring value stocks, there could be a shift in their performance in the near future.

Value Stocks Struggle as Growth Stocks Soar

In recent years, value stocks have struggled to keep up with the soaring success of growth stocks. During the market downturn of 2022, value stocks took a hit, with the iShares Russell 1000 Value ETF (IWD) falling 9.7% compared to the 29.9% drop of the iShares Russell 1000 Growth ETF (IWF).

However, in 2023, growth stocks made a strong comeback, leaving value stocks behind once again. This resurgence was largely driven by a handful of megacap technology stocks known as the "Magnificent Seven." Companies like Apple Inc., Microsoft Corp., Nvidia Corp., Tesla Inc., Amazon.com Inc., Meta Platforms Inc., and Alphabet Inc. contributed significantly to the S&P 500's 26.3% total return for 2023.

The outperformance of growth stocks has only accelerated since the start of 2024. The ETF tracking growth stocks has seen a year-to-date advance of 8.7%, while the value-focused ETF has only managed a 1.1% increase over the same period, excluding dividends.

However, there are indications that the tide may be turning towards value stocks. As U.S. megacap technology stocks experienced a retreat, the trend of growth outperforming value reversed. The value-stock ETF saw a 0.9% increase in share price, while the growth stock ETF experienced a slight decline of 0.3%.

This reversal reflects a broader shift in market leadership, with small-cap stocks outperforming the highflying Nasdaq Composite on Monday. The Russell 2000 index, which tracks small-cap stocks, experienced a 1.9% increase, while the Nasdaq Composite was down 0.1%. Additionally, small-caps also outperformed the S&P 500, which saw a meager 0.1% increase.

This positive movement for small-cap stocks marks a significant milestone for the Russell 2000 index, as it enters positive territory for the year for the first time since January 1, according to Dow Jones Market Data.