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The U.S. economy expanded by a stronger-than-expected 2.8% in the third quarter, but apart from a few robust quarters here and there, gross domestic product (GDP) has been almost flat on its back since the recession ended in June 2009. Real GDP growth has averaged just 2.3% over this period (through September 30, 2013),1 and few expect that to improve much in the near term. In fact, the International Monetary Fund projects expansion of just 2.6% per year for the U.S. economy over the next three years.2
This prospect suggests that investors should consider investing in growth stocks. Although it is well-established that the value "style" of investing historically has beaten the growth "style" over the long term, for many investors, tilting their portfolios toward growth may be more appropriate.
Growth investing may make sense for some investors, especially at a time when the economy is struggling. As Chart 1 shows, growth3 has historically tended to outperform value4 when the economy has contracted, or has grown at a slower pace according to Bloomberg. Value led the way during the short recession that ran from January 1980 through July 1980, for example, but tended to lag growth during the longer recession that ran from mid-1981 almost through the end of 1982. But as the economy roared back, value beat growth fairly decisively. Likewise in the early 1990s, the two styles traded places during the recession and subsequent recovery. And although the outperformance was not consistent, growth beat value in the recession that ran from December 2007 through June 2009.
Source: Bloomberg, Bureau of Economic Analysis, and International Monetary Fund. Data through September 30, 2013. Projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
Historically speaking, growth and value investments tend to react differently during the economic cycle. Since value stocks are often cyclical in nature, they may benefit from the increased spending that usually occurs during an economic expansion. Growth stocks may also perform well during an expansion, but they may also be out of favor during market downturns, when investors pay more attention to price ratios. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Performance during other time periods may be different or negative. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future. Please refer to "Important Information" regarding the economic indicator data in these charts and index information.
Past performance is no guarantee of future results.
Of course, there are no guarantees this pattern will always hold. A particularly glaring exception, for example, occurred after the dot-com bubble of the late 1990s. Growth outperformed value even as the economy was growing in excess of 4%, but value surged after the market collapse in 2000, even though the economy was slipping into recession. Growth stocks may have struggled because they had become so overvalued that outperformance became difficult, especially as the bubble collapsed.5
Growth investing is often viewed as the riskier of the two styles, and it does come with its own particular hazards. But in many ways, it carries less risk than value investing. In fact, its underlying premise is rather bearish about broader economic fundamentals, according to style investing expert Richard Bernstein. The premise, according to Bernstein, "is that the economy will be so poor and the profits cycle so weak that investors [must] search out those few companies that might actually be able to grow in that environment."6
Unlike value companies, which are typically sensitive to the business cycle, growth companies often derive their ability to increase revenues and profits from sources that aren’t as dependent on the vicissitudes of the broader economy. Research has confirmed that the fundamentals of value companies worsen far more than those of growth companies during recessionary periods, according to Russell Investments.7 Often growth companies are fueled by a game-changing product or service (think Apple and Amazon).
It follows, therefore, that growth companies frequently enjoy greater financial health as well. Often they are flush with cash owing to a leading market position and strong pricing power, reducing the need to take on debt. Their robust financial condition can give them staying power in the event of an economic downturn.
For growth investors, however, one obvious risk is valuation. While price-to-earnings ratios and other valuation metrics are a critical concern for value investors, growth investors tend to be less bothered when these measures continue to rise, believing that high multiples reflect realistic market expectations of rapid growth. But disregarding valuation can result in overpaying for a stock or failing to sell it before it runs out of steam.
Here, attention to market dynamics can help, says Thomas O'Halloran, Lord Abbett Partner & Director of Growth Equity and Small Cap Growth. If, for example, he had taken a large position in a biotech firm and had seen it rise substantially, O'Halloran would consider selling it if his team noticed "a pattern in the market where the micro-cap and the small cap biotechs had excessive outperformance, and then stopped going up," he told Investor's Business Daily.8
1 Bureau of Economic Analysis.
2 International Monetary Fund.
3 As represented by the Russell 3000 Growth Index.
4 As represented by the Russell 3000 Value Index.
5 Mary Fjelstad and Dave Hintz, "Surviving U.S. Recessions with Style," Russell Investments, May 2009.
6 Richard Bernstein, Style Investing (John Wiley & Sons, 1996).
7 Y. Xing and L. Zhang, "Value versus Growth: Movements in Economic Fundamentals," working paper, University of Rochester, August 2004; cited in Mary Fjelstad and Dave Hintz, "Surviving U.S. Recessions with Style," Russell Investments, May 2009.
8 Marie Beerens, "Analysis Helps Lord Abbett Fund Exit Tesla with Gain," Investor's Business Daily, November 12, 2013.
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.
Historically speaking, growth and value investments tend to react differently during the economic cycle. Since value stocks are often cyclical in nature, they may benefit from the increased spending that usually occurs during an economic expansion. Growth stocks may also perform well during an expansion, but they may also be out of favor during market downturns, when investors pay more attention to price ratios. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Small cap company stocks tend to be more volatile and can be less liquid than large cap company stocks. Small and Micro-cap companies may be less able to weather economic shifts or other adverse developments than larger, more established companies and may have less experienced management and unproven track records. Small and Micro-cap companies may rely on limited product lines, may have more limited financial resources, and may be more susceptible to setbacks or economic downturns. No investing strategy can overcome all market volatility or guarantee future results.
Gross domestic product (GDP) is the market value of all finished goods and services produced within a country. It is a measure of an economy's output.
Real GDP growth is the growth in GDP adjusted for inflation.
P/E ratio represents the price of a stock divided by its earnings per share.
The Russell 3000® Growth Index measures the performance of those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 3000® Value Index measures the performance of those Russell 3000 Index companies with lower price-to-book ratios and lower forecasted growth values.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.