Growth or Value?
Ben Stapley, portfolio manager for the JPM UK Equity Growth Fund discusses the relative performance of value stocks versus growth stocks.
In recent years a key theme for investors to get to grips with has been the relative performance of value stocks versus growth stocks. The underperformance of value and outperformance of growth is shown by the downward sloping blue line in the chart below.
Chart 1: The performance of value stocks vs. growth stocks and the shape of the yield curve
We’ve overlaid the grey line which shows the spread between 3 month and 5 year government bond yields. It highlights a close relationship. Indeed, the level (and shape) of the yield curve has been an important driver of investment styles because growth stocks benefit from falling yields (through the discounting of longer duration earnings streams). The grey line shows that the spread is currently negative meaning the yield curve is actually inverted here. Very simply, this is indicative of a tough environment for value stocks, especially financials which will struggle to make profits when there’s little differential in yields.
Another implication of falling bond yields is the increasing attractiveness of equity valuations compared to bonds. Looking at dividend yields, for example, the next chart illustrates that equities are cheap both relative to bonds and to their own history (as shown by the median lines). Remarkably, ten year gilt yields are now below the prior lows of 0.5% (which were last seen following the Brexit referendum). The spread between bond yields and dividend yields has opened up materially over the past 12 months
Chart 2: 10 year bond yields compared to equity dividend yields
What does this mean for the valuation of growth stocks compared to value stocks? The following chart shows the dividend yields for the MSCI UK Value index (grey) and the MSCI UK Growth index (blue). Whilst we can see that value stocks are suddenly looking very cheap with a yield in excess of 6%, it is worth noting that growth stocks are still offering a reasonable dividend yield of 2.5% which is broadly in line with its ten year median. The three biggest constituents of the MSCI UK Growth index are AstraZeneca, Diageo and Unilever, examples of blue-chip names with resilient earnings streams.
Chart 3: Dividend yields of value and growth stocks
One final point to make is about the impact of inflation. Unlike a bond’s coupon (which is fixed), equity dividends tend to grow in line with corporate earnings, hence they offer a partial inflation hedge. However, the real yield on a ten year gilt (yield minus inflation) is currently minus 1.4%. So, even after a strong period of performance from growth equities, you can enjoy a real yield uplift of around 4% over gilts from investing in some of the UK’s best known blue-chip growth companies.
Ben Stapley is portfolio manager for the JPM UK Equity Growth Fund