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09/15/17 04:34:47 PM
THE OUTLOOK

STICKING WITH GROWTH



Portfolio managers often choose different styles or factors for portfolio construction depending on the objective of the portfolio be it growth, value, momentum, dividends or volatility. S&P Global has indices based on a number of these styles that investors can use as benchmarks when building their portfolios. Reviewing a number of these indices on a year-to-date basis, it is probably not surprising that the pure growth, growth and low volatility indices have been the winning factors in 2017.

Technology, the poster child for growth, is leading the market this year, advancing 25.7% through September 12. The sector's earnings growth of more than 20% in the first half of the year easily outpaced any other sector in the index (if you exclude energy's rebound from nine quarters of declines). Technology represents more than 30% of the pure growth and growth indices. Also, the Chicago Board Options Exchange Volatility Index (VIX) has averaged 11.5 since the start of the year, below the 19.5 historical average going back to 1990. This has benefited low volatility focused portfolios.

Value indices underperformed this year, a reversal from the leadership position held in 2016. In the past nine years, value only outperformed growth once (in 2012), making last year's rotation into value notable. Prior to last year, and going back to the years leading into the financial crisis, investors favored growth stocks as a lack of economic growth made it difficult for value oriented stocks to perform well. Value stocks are usually those whose companies are undervalued versus their own or competitor fundamental metrics, and will benefit from an economic environment with solid growth. Industrial and financial firms are usually considered value stocks. Late last year, the tide shifted as value received a boost from the presidential election as investors anticipated the implementation of pro domestic growth policies from Donald Trump that would benefit the economy.

As gridlock became the name of the game in Washington, the value trade quickly unwound. Uncertainty about the policies expected to boost corporate and consumer profitability drove investors back to the growth sectors in mid-April.

The S&P 500 Growth index advanced 17.6% year-to-date, and the S&P 500 Value Index is 4.6% higher since the start of the year. That compares with an 11.5% rise in the S&P 500. In April, CFRA signaled that we expected growth to be the leader this year as economic uncertainty would weigh on the market, especially in the near term. While valuation for the growth index, at an average price-to-earnings (P/E) ratio of 29.4x, is expensive compared to the overall S&P 500 as well as the technology sector, we note that the Sharpe ratio is attractive. At 1.09, the ratio offers a solid risk-adjusted return, and is the fourth highest of the factor indices we analyzed for this report. A portfolio with a higher Sharpe ratio is typically considered superior relative to its peers.

November is quickly approaching, which begins the seasonally strong period of the year for cyclical stocks. During this period, technology is historically a solid performer, which means momentum shouldn't slow down for the sector. As mentioned above, technology represents 36.5% of the S&P 500 Growth index and 31.8% of the S&P 500 Pure Growth index. The second largest component of these indices is the consumer discretionary sector, representing 16.1% and 19.7% of each index, respectively. Consumer discretionary has historically returned 10.4% to investors during the November through April period. If the end of this year follows the typical path for these cyclical sectors, growth-focused stocks and indices should continue to outperform. CFRA thinks this is especially true as policy and geopolitical uncertainty remains prevalent in the market.

Depending on your time horizon, CFRA has top ranked large-cap growth and large-cap value ETFs to consider. Vanguard Growth Index ETF (VUG 133 OW) and iShares S&P 500 Growth (IVW 143 OW) are examples of growth ETFs, while PowerShares Dynamic Large Cap Value Portfolio (PWV 37 OW) and iShares S&P 500 Value (IVE 107 OW) are value ETFs we like.

LINDSEY BELL, CFRA Investment Strategist

 

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