MEGA-CAP TECHNOLOGY growth stocks were huge winners during the last bull market and even during this year’s coronavirus crash. But recently, they’ve lagged, while small-cap value companies have posted robust gains.
Indeed, after a decade of lackluster performance, diversified portfolios that contain sizable holdings of foreign, small cap and value stocks have started to perk up. Could mean reversion finally be taking place? Are we at an inflection point?
It could be—or it could be just another twitch in the market, a head fake, as it were. After all, value stocks performed relatively well at times in 2019 and international shares had a great 2017. But those turned out to be just blips on the radar. What makes this time different?
COVID-19 crushed small and value stocks. Those companies were—and are—bearing much of the brunt of the pandemic’s economic fallout. We’re talking about outfits like restaurants, airlines and real estate investment trusts.
Meanwhile, firms that sell online have benefitted from the shift away from physical contact and toward staying at home. In addition, mega-cap technology companies had massive amounts of cash on their balance sheets, so they were able to weather the storm better. The typical American family may not have had an adequate emergency fund, but these companies sure did.
Maybe COVID-19’s stock market drubbing was the final washout after years of underperformance by small, value and foreign stocks. The recent flush also brought about attractive valuations.
According to data from Topdown Charts, U.S. stocks are trading at about 27 times their 10-year average earnings. That’s about one standard deviation above the average since the 1980s. By contrast, foreign stocks are at 14 times 10-year average earnings, or about one standard deviation below the long-term average. What about value versus growth? Like foreign shares, value stocks are at historically cheap levels relative to growth.
Near-term relative returns have also improved. Since mid-March, small-cap value is up 50%, outperforming large-cap growth’s 37% gain. The U.S. versus foreign gap is less startling. But since mid-April, Vanguard Group’s total international stock index fund has beaten the firm’s total U.S. stock market index fund by a small amount.
We often hear that the time to buy is when there’s blood in the streets. The same idea holds true for portfolio allocation decisions. Foreign stocks have seemingly never been more out of favor, while small-cap value sentiment is maybe the worst ever, thanks to COVID-19.
I’m not encouraging anybody to engage in market timing. But I know many U.S. investors suffer from home bias and recency bias, and that’s led them to hold risky, undiversified portfolios focused on large-cap U.S. growth stocks. My point: We don’t know whether this is an inflection point, but it is a warning signal. If you’re one of those folks whose portfolio is all S&P 500 or all large-cap growth, perhaps it’s time to diversify.
Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Getting Back In, Riding the Bear and Stepping Up. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.