Style Postmortem

Valuations 

This was confirmed in valuations.  To say the valuations of growth indices were stretched at the beginning of 2022 would be an understatement. The average PE ratio across the S&P 500 Growth, Russell Growth and Bloomberg Global Growth sat at 33x. The average index percentile ranking based on their historical valuations was 95th – really close to the top. This was similar across other metrics, including price-to-book and price-to-sales. 

Value factor index valuations were not cheap based on their respective histories, as the markets, in general, were more expensive. But they were nowhere near as stretched as you can see in the chart below. 

Earnings Growth 

There is a long historical relationship between earnings growth and relative style performance. Generally, when earnings growth is strong, value outperforms growth. Few intuitive factors behind this; earnings growth is more abundant when the economy is doing well. And the value factor has a greater representation in many economically sensitive sectors. Meanwhile, when earnings growth is scarce, growth tends to do better. This is also a scarcity issue because when growth is hard to find, those companies that can still grow often fetch a premium. 

So at the beginning of 2022, what did earnings look like? Earnings growth looked pretty good. For the S&P 500, estimates sat at $209 for 2021, growing to $223 in 2022 and $241 in 2023. Solid high single-digit growth. This favoured value over growth. 

Yields

When yields rise, as measured by the 10-year U.S. Treasury yield, value tends to outperform growth, and vice versa. This is driven by a couple of factors. Higher yields are more common when economic growth is accelerating, which makes earnings growth more abundant to favour value. Plus, growth companies tend to be viewed as longer duration based on future cash flows that are often much further in the future compared to value companies. Lower yields make the present value of those more distant cash flows worth more, favouring growth.

So at the beginning of 2022, yields had started to come off the troughs caused by the pandemic and subsequent monetary stimulus. But the path was clearly higher in 2022, which favoured value. 

Putting this all together, performance, relative valuations, earnings growth and the trajectory of yields all favoured value over growth as 2022 got going. A value tilt was clearly an easy decision and the right decision. 

But then something changed in 2023 

Value’s outperformance in 2022 has certainly reversed in 2023 so far. So how did the above metrics stack up on January 1st of this year? Perhaps the strong run by value was due for a reversal, simply given the magnitude of the move. But other factors also lined up better for growth or at least much less of a headwind. 

Valuations

Based on the S&P 500 style indices, the valuation spread between value and growth, which was at historic extremes at the beginning of 2022, had narrowed considerably. In January 2022, growth traded with a 10point premium to value. A year later, in

January of ’23, this had narrowed to less than a 2-point premium.  Growth has traded on occasion with a lower valuation than

Value but very rarely. So safe to say a mere 2point premium for growth was check mark favouring growth over value [see previous

chart on style  valuations above].

Earnings Growth

Earnings growth, which was abundant in  2022, gradually declined. Recall there was high single-digit earnings growth in January

2022, 7% earnings growth forecast for the coming year compared to the previous. As estimates declined during the year, earnings

growth expectations did as well, down to 2% earning growth in  January 2023. Once again, this lower earnings growth environment favoured growth over value.

Yields

It doesn’t seem to be the absolute level of yields that matters; it is the change in yields that seems to correlate  most with relative

equity-style performance. 2022 saw yields rise materially, from 1.5% to 3.9%. This was  good for value. So far in 2023, yields have

moved around a bit but have been largely stable, sitting at 3.8%  today. This may not favour growth, but it clearly isn’t the headwind compared to 2022.

At the onset of 2023, it may not have been a slam dunk that growth would outperform value, but it was a materially better environment for growth compared to the previous year. 

Final Thoughts 

Whoops, we should have clearly pivoted back to Growth from Value at the beginning of 2023, hindsight being 20/20 and all. Maybe it was the overconfidence that was fed by being so well positioned in 2022 had us believe there was more room to run for value. Regardless, the setup in early 2023 clearly favoured growth or at least a more neutral style stance. 

This, of course, raises the more important question, what about the 2nd  half of 2023 and beyond? In the table below, we have summarized our signals/methodologies for style tilts, including the readings in January 2022, 2023 and in July 2023.   

We would not chase this growth performance run as too many of the signals are now favouring value once again. The lesson of this postmortem is to really develop and trust your process and don’t be afraid to pivot. If you sit on a great trade for too long, it can become less of a good trade. 

— Craig Basinger is the Chief Market Strategist at Purpose Investments 

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only. 

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc. 

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