What have you uncovered about the performance spread relationship between value and growth?
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So we recently completed some research into value versus growth performance and the spread of performance, and we uncovered two factors that people may not have been aware of, that have an effect. The first is economic vitality. So there are a variety of measures for that. One of the ones that we find useful as a leading indicator is ISM manufacturing new orders. So what that looks at is manufacturing companies, are they seeing an increase or a decrease in the orders they're receiving today that they're going to fulfill in the future?
So that metric actually uses 50 as a dividing line; above 50 is expanding orders, below 50 is contracting. Over roughly the last 40 years, that measure has averaged about 54. So a slight, modest amount of growth. However, more recently we’ve seen measures that are above 60. That is significant and robust growth. And that macro indicator actually syncs with the research we’re doing with individual companies, and talking to management, that this is a very strong economic environment.
What does history tell us if that strong economic environment continues, might affect value versus growth? Well, let’s look at all periods that were below 60. The spread between value and growth performance on a following 12-month basis was 120 basis points outperformance for value. Decent; not enormous. What about over 60? In one-year periods following when the ISM new order index was 60 or over, value outperformed growth by an average of over 500 basis points. So if we are going to continue with this strong economy, that may be very relevant to know in positioning portfolios on value versus growth.
Value/Growth Performance Spread in ISM New Orders Regimes
Russell 2000 Value Minus Growth Average 1-Year Rolling Returns from 12/31/78 through 9/30/18
The second factor is volatility. And people may not instinctively say that a change in volatility level would affect the spread between value and growth. But history shows otherwise. So we have been in a very low volatility environment. One way to measure that is standard deviation of the Russell 2000 Index. One thing we like to look at is, over the last five years, what has that standard deviation been? Actually, over the last five years it's been among the lowest ever recorded, but we would take a look at the low volatility environment and say 16% or below standard deviation. Well, how did value versus growth do there? Well, it was, value outperformed by about 190 basis points in the low volatility environment.
Value/Growth Performance Spread in Volatility Environments
Russell 2000 Value Minus Growth Average 5-Year Annualized Rolling Returns From 12/31/78 through 9/30/18
What about all other environments? Say, average or above average. Well, the spread on a 5-year basis between value and growth in all other environments was over twice as high. Remember, it was 1.9%, 190 basis points for low volatility? It was over 400 basis points in all other market environments. So it seems to us that if volatility is going to continue to increase, that will be tailwind for value outperformance versus growth.
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The thoughts and opinions expressed in the video are solely those of the persons speaking as of October 15, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
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The ISM Manufacturing Index (ISM) monitors employment, production, inventories, new orders and supplier deliveries.
Standard deviation is a statistical measure within which the indexes’ total returns have varied over time. The greater the standard deviation, the greater an index's volatility.
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