Positioning client portfolios for a potential market cycle change
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DJ TIERNEY: Hi, I’m DJ Tierney, Senior Portfolio Strategist supporting Schwab Asset Management. I’m here to highlight that right now is an important time for advisors to take a close look at client portfolios and determine if they are positioned for potential market cycle change, where value and international stocks may take over performance leadership from growth and domestic equities.
There is a credible argument that equity market leadership has begun a shift to a new market cycle, where value stocks could outperform growth stocks and international stocks may outperform US stocks. Here’s a graph of the last 25 years comparing relative performance of growth stocks versus value stocks globally. The blue line is growth. The yellow line is value. It is clear that growth has had a strong run over the last 15 years outperforming value. The cumulative results are quite divergent now.
Looking back at other times, you can see that there have been cycles of value outperforming growth, notably from 2000 to around 2007. The blue columns highlight periods where the US yield curve inverted, short-term rates were higher than long-term rates, a common phenomenon in the US economy is in transition, and they have proceeded previous cycle changes. The most recent was 2019 to 2020. Why could we be seeing a cycle shift now?
Number one, well, we did have a US yield curve inversion occur going into the COVID-19 pandemic. Many market strategists noted that the COVID-19 pandemic accelerated many existing investment trends. Certainly, new technologies and social media companies were heavily utilized while we were confined to our homes. Perhaps the impact of COVID-19, the pandemic, delayed the regime shift for a time, but now the vaccine-led recovery will allow it.
Number two, comparing the valuation metrics for stocks in the growth category versus stocks in the valuation category, they are at historic extremes. The two have never been more far apart.
Lastly, if you see changes in the most recent part of the curves, this illustrates that growth performance has turned since the last quarter of 2020.
Note that these cycles of leadership have previously played out, not in months, but rather over years.
The second graph shows a parallel theme with US versus international stock returns. US equities have outperformed international stocks in aggregate over the last 30 years, not always, but in aggregate. Again, there have been periods of international outperforming US, notably the late 1980s and 2000 to 2007. Also, again, the blue columns highlight US yield curve inversions that have preceded cycle changes.
Could markets be poised for another era of international outperformance? Like the relative performance of value outperforming growth starting in the fourth quarter of last year, international, non-US, also began outperforming US stocks in the fourth quarter of last year. Many US investors are under-allocated to international to begin with. Now, the US outperformance has likely expanded that over allocation.
If advisors haven’t been taking intentional actions like rebalancing portfolios, client portfolios may have a heavier allocation to growth and US equities by virtue of price appreciation. For growth stocks, this is certainly true in traditional indices, like the S&P 500, where growth of technology companies now make up a significant portion of the index.
If this logic makes sense to you and you believe a new cycle is beginning, ETFs offer many convenient choices to access both the value factor and also increase exposure to international equities. ETFs can be effective components in a diversified portfolio comprised of long-term strategic allocations and a disciplined approach to rebalancing over time.
I hope you found this interesting and helpful. For more information, please reach out to your Schwab Asset Management representative.
D.J. Tierney, Managing Director and Client Portfolio Strategist, discusses a potential market cycle change where value and international stocks may take over performance leadership from growth and domestic equities.