Stocks rallied in the second quarter thanks to significant fiscal and monetary stimulus (see the first quarter market commentary, “Bumpy Start to 2020”). The S&P 500 Index was up 20.5% for the quarter as investors anticipate a rapid economic recovery from the coronavirus shutdown.
The recovery from the March bottom was very fast. As of June 30, 2020, the S&P 500 Index was down just 3.1% for the year. Technology and Consumer Discretionary stocks have been the winners this year, up 15.0% and 7.2%, respectively. While value sectors, such as consumer staples, energy, and financials have lagged the overall market as the economy shut down with stay at home orders.
Treasury yields stayed rather stable during the quarter. The 10-year Treasury yield ended the quarter at 0.66%. Corporate bonds outperformed as the Federal Reserve started its bond buying program, acting as a backstop for liquidity. Corporate bonds were up nearly 9% for the quarter.
Below is a table highlighting various market index returns over the past 3, 12, and 36 months:
Growth stocks have been on a tear for the past three and half years. Since January 1, 2017, the Vanguard Growth Index Fund ETF (VUG) has outperformed the Vanguard Value Index Fund ETF (VTV) by almost 84%! That means that if you invested $10,000 in each index on January 1, 2017, on June 30, 2020 you would have $17,999 in VUG and $10,637 in VTV.
Returns are from January 1, 2017 through June 30, 2020 for iShares Core S&P 500 ETF (IVV), Vanguard Value Index ETF (VTV), and Vanguard Growth Index ETF (VUG)
Looking at the trailing three years as of December 31, 2016 (1/1/2014-12/31/2016), VTV had a slight edge of just 2%. Looking at the chart below, it is easy to see that VUG was beating VTV for much of that time period. It wasn’t until the end of 2016 that value significantly outperformed growth.
Returns are from January 1, 2014 through December 31, 2017 for iShares Core S&P 500 ETF (IVV), Vanguard Value Index ETF (VTV), and Vanguard Growth Index ETF (VUG)
Any way you look at it, it has been painful to be a value investor for many years. As we went into the coronavirus pandemic of 2020, growth continued to outperform value. During the first quarter of 2020 the Russell 1000 Growth Index was down 14.1% while the Russell 1000 Value Index was down 26.7%. The bounce off of the bottom was no different. Over the second quarter of 2020, the Russell 1000 Growth Index was up 27.8% while the Russell 1000 Value Index was up only 14.3%. This just added to growth’s significant win streak.
As shown below, this outperformance and the willingness for investors to pay more for growth, has caused the relative valuations to widen. Looking at the difference between forward price to earnings ratios, it appears that value is cheap relative to growth. It’s important to remember that just because growth is overvalued does not mean that it has to underperform. There can be significant time periods of under or out performance.
Source: JP Morgan Guide to the Markets
Growth is represented by the Russell 1000 Growth Index and Value is represented by the Russell 1000 Value index
Growth is now one standard deviation overvalued relative to value. This is not even to close the relative overvaluation seen during the tech bubble of the late 1990s and early 2000s, but we all know how that ended.
For us, many of our client portfolios have an overweight to growth. This is both intentional and the result of the outperformance noted above. As we review portfolios and discuss our overall portfolio allocations, we continue to favor a growth tilt, but keeping an eye on general valuations is an important part of monitoring portfolios.
Breadth of the Market
As of June 30, 2020, the top 5 holdings in the S&P 500 Index (Microsoft, Apple, Amazon, Alphabet (Google), and Facebook) made up 21.6% of that index. When the top five stocks make up such a large portion of the entire index, the performance of those stocks will have a significant impact of the performance of the overall market.
To show the impact of the large weighting, we can look at the performance of the S&P 500 (measured by the iShares Core S&P 500 ETF, IVV) vs the Invesco S&P 500 Equal Weight ETF (RSP). Instead of being a market cap weighted index as IVV is, RSP takes the same 500 stocks and buys and equal percentage of each.
The affect is that the larger companies will not have as much of an impact on overall returns compared to the index.
As seen below, the equal weight index underperforms the S&P 500 by 20% from January 1, 2017 through June 30, 2020. The large technology stocks have driven much of the recent S&P 500 performance. The average stock in the index has returned much less than the index itself.
Returns are from January 1, 2017 through June 30, 2020 for iShares Core S&P 500 ETF (IVV) and Invesco S&P 500 Equal Weight ETF (RSP)
The two analyses highlight a few important observations. First, there has been an enormous difference in market returns based on the how are you invested. Growth investors have enjoyed a fabulous bull market, thanks partly to outperformance of the large tech companies, while value investors have been more or less kept on the sideline. The valuation gap will ultimately attract capital to value stocks, but timing the change in investor sentiment is always difficult.
Second, the number of stocks participating in market’s move higher has been narrow. We would prefer to see a more inclusive market, where more sectors and companies are participating. In general, we feel this would suggest a healthier overall economy.
Stay safe, enjoy the summer with family and friends.
JR Geld, CFA, CFP®
Philip E. Huber, Jr, CPA, CFP®
HWA Financial Group
3448 Ellicott Center Dr.
Ellicott City, MD 21043