Value versus Growth Over 25 Years in the US and Asia
Gene Reilly, Greenwich Quantitative Research’s Chief Investment Officer, speaks with Leyla Gulen about the contrasting performance of Value vs. Growth in the US and Asia over the past 25 years
Leyla Gulen (00:00):
Hello, and welcome to Quantitative Investment Insights presented by Greenwich Quantitative Research. Greenwich Quantitative Research is a hedge fund based in Greenwich, Connecticut focused on market neutral quantitative investing in the Asia Pacific region. I'm here with the company's founder and chief investment officer Gene Reilly. Gene has 30 years of experience in trading and investing including 19 years living and working in Asia. Gene was an early pioneer in quantitative trading and has been involved in the space for over 18 years. Our topic today is value versus growth. Now Gene, value and growth have been in the news a lot from late 2021 until today. Can you please let us know why value and growth are making investment news these days?
Gene Reilly (00:48):
Leyla, thanks so much for that great introduction. It's really nice to be talking to you again today. Growth has strongly been outperforming value for most of the period following the Great Financial Crisis. It's been one of the longest and strongest periods of growth outperformance, so it's attracted a lot of investor attention. However, starting in late 2021, the value / growth spread reversed and growth has sharply underperformed, both value stocks and the broader market. We believe there are very interesting insights to gain by taking comparative look at how value and growth have performed over the last 25 years in the US and Asian markets and providing reasons for why there are differences.
We're going to discuss the value and growth phenomena in the market. I'd like to clarify, however, at Greenwich Quantitative Research, that we are neither value nor growth investors nor do we necessarily advocate pursuing such strategies. Value and growth perform differently over different periods of time and someone who is pursuing either a growth or value strategy will suffer sometimes long periods of underperformance and have periods of really great performance. We seek to provide superior returns really through all market cycles. Additionally, there's been a lot of debate between smart beta as well as style factor timing. We're advocates of really neither. In our investment approach, we seek to be neutral to all style factors, including value and growth.
Leyla Gulen (02:11):
Well, when I hear value investing discussed in the news, it is often associated with Warren Buffet, buying a stock at a discount, something that has value, sounds like a compelling investment concept.
Gene Reilly (02:22):
Yes, the current concept of value investing dates back to the 1920s and is usually credited to Benjamin Graham and David Dodd who were finance professors at Columbia, and taught a strategy of buying deeply undervalued companies. Warren Buffet was Graham's protege, therefore, he's very associated with the strategy. Some investors are still very successful at making exceptionally well timed purchases of value stocks. However, value investing is no longer an all weather strategy. A pure value approach doesn't work like it used to in the Graham / Dodd era or in the early days of Warren Buffet. In recent decades, investors who pursue a value approach have seen their techniques work only during specific market regimes and have long periods of underperformance.
Leyla Gulen (03:06):
Can you explain briefly how investors price value and growth stocks and what factors influence their performance?
Gene Reilly (03:13):
Value stocks derive the majority of their value from stable near term free cash flows, which can be extrapolated into the future with a degree of confidence. Examples of sectors include financials and utilities. Growth stocks derive the majority of their value from expected future earnings. Sometimes they have lower or even negative near term earnings. The examples are startup companies in the technology sector, healthcare, biotechs, for example,
Leyla Gulen (03:39):
How does the macro environment affect value and growth performance?
Gene Reilly (03:43):
Conventional wisdom is that value stocks tend to outperform when economic growth is very strong or extremely weak, and when interest rates rise. Although a consistent period of rising interest rates hasn't happened for decades. Now, we don't really have any recent data on the interest rate cycle and value stocks that's relevant to the current market regime. Growth stock performance in the US over the past 10 years has occurred to the backdrop of historically unprecedented monetary easing. Growth stocks have historically outperformed when investors are extremely enthusiastic about the introduction of a new technology. Some of the examples going back through history, were the advent of the railroads, the introduction of television and the early days of the internet are some examples.
Leyla Gulen (04:32):
Why did growth perform so well in the US after the Great Financial Crisis up until very recently?
Gene Reilly (04:38):
Growth has benefited really from record low bond yields. Good growth companies were harder to find in the period post the Great Financial Crisis. Until 2016, the economic recovery was weak and there were persistent earnings downgrades in this environment. It was hard to find companies and sectors with dependable growth prospects. Those companies that offer dependable growth got rewarded by investors. The technology sector has had very strong growth and has a large weight in the growth index. The rise in margins in technology has also been a big contributor to the outperformance of growth. As of 2022, the technology sector comprises about 48% of the MSCI US growth index. For the S&P 500, the information technology sector is the largest sector at 28%.
The financial sector is currently ranked fourth with a weight of 11.2%. For example, in October of 2007, the financial sector was the highest weight in the S&P 500 at 19.2%. All information technology was ranked second at 16.9%. Low capital intensive sectors have outperformed high capital intensive sectors for two reasons. Many of the lowest capital employee companies are technology companies, which have performed extremely well. You could argue that the impact of quantitative easing and close to zero interest rates have perpetuated numerous low margin players in older industries that normally would've been spurred to consolidate, if it was a higher interest rate environment.
Leyla Gulen (06:13):
Interesting in your explanation of why growth outperformed, we can see a number of reasons for why value underperformed. Would you add anything else of value to this?
Gene Reilly (06:23):
Weak growth and low interest rates negatively impacted the returns of cyclical sectors, which have a high weight in value indices. Banks have been cited as an example of a value play. However, to be a little more nuanced on this, the Great Financial Crisis was essentially a banking crisis. The cycle of banking crises and their recoveries have their own unique characteristics and cadence. People would cite as a good example of value timing, was Warren Buffet's investment in the banking sector during the financial crisis, which were structured as debt on the downside and equity warrant participation on the upside in order to mitigate the need for him to precisely time this cycle.
Leyla Gulen (07:01):
Can you compare the performance of value versus growth in the US and Asia during the dot.com and Great Financial Crisis periods?
Gene Reilly (07:09):
We looked at the value growth spread over the past 25 years in both the US and Asia. In the US, value underperformed growth by 43 percentage points in the period leading up to the dot.com crash. We would define that as January, 1997 through February, 2000. Following the dot.com crash, value rallied 37 percentage points from its low and outperformed growth. And that was in the period from February, 2000 until July, 2006. From December, 2008 to November, 2021 value, again, underperformed growth, this time by 57 percentage points. The post Great Financial Crisis period is historically the longest period of underperformance for value versus growth in the United States.
Leyla Gulen (07:53):
Yeah, the value / growth spread performed significantly worse in the post-GFC period, underperforming by an additional 14 percentage points. How did Asia compare during these two periods?
Gene Reilly (08:05):
Leyla, that's a great question. There are interesting differences between Asia and the US during both periods. Asia Pacific as a region followed the same pattern as the US, but value underperformed growth to a lesser degree during both periods. Coming into the dot.com crash, value underperformed growth by 25 percentage points in Asia versus 43 percentage points in the United States. Post the GFC, value underperformed growth by 49 percentage points in Asia versus 57 percentage points in the United States. Then post Great Financial Crisis, value underperformance in Asia started later and ended earlier, compared with the United States. Specifically, value underperformance didn't really begin in Asia until March, 2013 and it ended in February, 2021, before the US value rally started in November, 2021.
Leyla Gulen (08:56):
Why do you think the value versus growth spread in the US underperformed more in both periods compared with Asia?
Gene Reilly (09:03):
Leyla, the biggest contributor to the difference during both periods is the domination of tech stocks as a driver of growth. The dot.com rally and crash was driven by technology stocks. Post the GFC, technology stocks have been the largest contributor to growth's outperformance in the US, as we discussed. In both periods, for investors who wanted to gain exposure to growth, tech stocks offered the best growth story. Tech's performance was strong and the weights of tech stocks and growth indices increased over time, making growth outperformance even larger. It's harder for a pure growth company in Asia that isn't making money to meet the listing requirements in many Asian markets. US listing requirements allow companies that have no earnings and are losing money to go public. Many, but not all, Asian exchanges have profitability hurdles for listing.
For example, both Amazon and Facebook, at the time of their respective IPOs in the United States would not have met the listing requirements in some Asian countries, including China and Hong Kong. Consequently, investment during the early stages of growth is typically funded privately in Asia. Asia tech companies tend to be more capital intensive, hardware focused companies than in the United States. For example, Apple doesn't manufacture its own products. Much of the manufacturing is done in Asia. And a lot of that's done by a Taiwan company called Hon Hai. Apple trades in the United States at a PE of 28.9. Hon Hai trades at a PE of 10.5.
Leyla Gulen (10:34):
Yeah. How much has the US tech sector outperformed the tech sector in Asian countries?
Gene Reilly (10:40):
Leyla, in the US, the technology sector outperformed the Russell 1000 Index by 166% post the Great Financial Crisis as defined as December, 2008 through November, 2021. No other Asia technology sector came close to that level of outperformance. The best performing tech sectors in that period were in Korea and Taiwan, and both of those were up approximately 111% versus the market, but substantially below the US.
Leyla Gulen (11:08):
Japan was the dominant equity market in Asia prior to the Great Financial Crisis, and before China's equity market grew substantially. How has the value growth spread performed in Japan versus the US?
Gene Reilly (11:21):
In Japan, the value growth spread didn't sell off as much during the dot.com period, but was in line with US underperformance in the post Great Financial period. In the dot.com period, the under performance was 28%. In the post-GFC period, the underperformance was 57%.
Leyla Gulen (11:39):
What contributes to different performance in the value growth spread for Japan versus the US?
Gene Reilly (11:44):
Yeah, it's a great question. I would say there's several factors. In Japan, generally there is less private equity activity and significantly less activist investor activity, given legal systems isn’t favorable to activist investors. Consequently, some of the catalysts that exist in the US for unlocking value are not significant factors in Japan. Frequently, you hear the term value trap used to describe some of the companies in Japan where it's difficult to unlock their value.
Leyla Gulen (12:13):
How did the value / growth spread perform in China and India?
Gene Reilly (12:16):
China's market was essentially closed until 2002 when QFII was launched. It didn't experience the value growth sell off during the dot.com period. Post the Great Financial Crisis, value underperformed growth by 30 percentage points in China, and by only eight percentage points in India. In contrast, with the consistent underperformance value in the United States, post the GFC, value experienced a large rally in China from December, 2010 to January, 2019, before selling off sharply. Value sold off gradually versus growth in India post the Great Financial Crisis until mid 2015, the spread didn't move from mid 2015 until mid 2020. From mid 2020 onwards, value moved up moderately.
Leyla Gulen (13:05):
What reasons can you give India and China significant value and growth performance difference?
Gene Reilly (13:10):
Many reasons potentially. It's a good question, Leyla. Both countries have restricted currencies, which further reduces the impact of US monetary policy, particularly in China, where the currency is managed. Both India and China have high retail participation. Retail trading exhibits a higher velocity, as well as a focus on the lower end of the capitalization spectrum. As a result, value and growth won't trend for as long given the unique characteristics of the China and Indian markets. While both China and India markets have opened over the years, there are still restrictions in place that reduce the level of foreign investor flows. Foreign investors would try to profit from the large gap between the value growth spread between the US and China and India if markets were more efficient. Such flows would likely reduce the spread.
Leyla Gulen (14:00):
How did Australia perform?
Gene Reilly (14:01):
In contrast to the US, where growth outperformed value strongly into the dot.com crash, in Australia, value outperformed growth from January, 1999 until mid 2003. Coming into the dot.com crash, value outperformed growth by 46 percentage points. Value underperformed growth from mid 2003 until mid 2009. Value did underperform growth post the GFC, but it started later in mid 2015 and ended earlier in October, 2020. Post the GFC, value underperformed growth by 21 percentage points.
Leyla Gulen (14:37):
Why would Australia perform so differently?
Gene Reilly (14:40):
Australia's economy and therefore stock market is mainly driven by domestic demand and exports to the Asian region. Materials and financials account for about 50% of the Australian stock market capitalization while technology is only about 3.5%. The technology sector boom and bust in Australia coincided with the beginning of a major period of outperformance in the material sector due to rising commodity prices. The material sector drove value outperformance versus growth. The weight of the technology sector was too small to impact the strong value outperformance trend.
Leyla Gulen (15:16):
So which countries perform similarly to the US?
Gene Reilly (15:20):
Coming into the dot.com crash, value underperformed growth in Hong Kong by 53 percentage points and in Korea by 51 percentage points, more than the US at 43% underperformance. The value sell off started later in Taiwan and it underperformed growth by only nine percentage points. Post the Great Financial Crisis in Hong Kong, Korea and Taiwan, the value growth spread tracked the US underperformance of value closely. Hong Kong value underperformed by 41 percentage points. In Korea, value underperformed by 35 percentage points, and in Taiwan, value underperformed by 49 percentage points.
Leyla Gulen (15:57):
Why did Hong Kong and Korea in both periods and Taiwan in the post-GFC period track the US performance much closer versus the other Asian countries?
Gene Reilly (16:07):
Yeah. Great question. Korea and Taiwan are both export economies with relatively large tech sectors. They're heavily influenced by the US tech cycle. For example, TSMC, Samsung, SK Hynix are all major chip makers. Hong Kong's dollar is pegged to the US. So Hong Kong imports the US interest rate policy.
Leyla Gulen (16:30):
Well, Gene, this has been a very instructive and timely discussion on value and growth with great insights from an Asian perspective. Thank you so much. Well, that's all the time we have for now. I'd like to thank you, our listeners and I look forward to covering more topics in the future. We'll see you next time.