Here’s something to think about as you rebalance your mutual-fund portfolio at the end of the year: Growth stocks, largely out of favor for the past several years, outperformed value stocks in November and may be positioned for a comeback in 2006.
Professional investors and fund managers have been finding attractive opportunities in growth for months now; in fact, growth has been performing well relative to value since May, said Stephen Wood, portfolio strategist with Russell Investment Group. This could signal a shift in the longer-term investment cycle.
“In the past five years, value has done OK, but the real story is that growth has been getting clobbered,” Wood said. Now that it’s started to take off, he added, “We don’t think growth will roll over and go belly up. Once a style comes into favor, it tends to stay there for years. You just had the fifth year of a value cycle. Do you get a sixth year? You could. But I’m not convinced we’ll see it.”
When financial professionals speak of growth investing, they usually are referring to stocks with strong earnings and revenue growth, or growth potential. This strategy differs from value investing, a style favored by bargain hunters like Warren Buffett, which seeks profits by accumulating shares of companies that are underpriced by fundamental measures. The theory behind value investing is that stocks like this won’t stay unloved forever.
During the tech boom, value investing was a tough strategy to follow; growth was king. But in the aftermath of the bubble, the perceived safety and lower volatility of value investing held wide appeal once again. With traditional value sectors, such as energy and real estate, dominating market returns in recent years, many portfolios have taken on a value tilt, whether investors realized it or not.
In November, good performance among tech stocks helped the broad-market Russell 3000 Growth Index post a 4.4 percent gain, compared with a 3.4 percent advance for the corresponding Value Index. The Value Index still holds the lead for the year, but its advantage has narrowed to less than a percentage point: It was up 6.34 percent for the first 11 months of 2005, compared with a 5.49 percent rise for the Growth Index.
This doesn’t mean you should dramatically realign your holdings.
But if your portfolio is overweight in value funds and stocks, it is probably a good time to reassess your exposure to growth. Fund flows suggest our tolerance for risk is already on the rise.
According to TrimTabs Investment Research, of the $2 billion that poured into domestic equity funds the week ended Dec. 7, more than a third went into aggressive growth.
Another potential influence on the outlook for growth is monetary policy. The Federal Reserve appears likely to continue to raise interest rates into the new year, which could have a dampening effect on the economy in 2006. That doesn’t necessarily signal a bad year for value, but it could mean the characteristics of growth stocks will be more prized.
What is certain is that at some point, the tide will turn, said Richard Buck, managing editor of FundAdvice.com, a publication of Merriman Capital Management in Seattle. Market cycles go on for several years, and when the pendulum has been moving in one direction for a long time, at some point it will swing back, he said. For this reason, it makes sense to maintain exposure at both ends of the spectrum.
“Will growth be the new hero in ’06? We don’t know. It’s impossible to know and anyone who says they know is lying and doesn’t know what they’re talking about,” Buck said.
