Julien's notebook: A renewed case for Growth Investing?

After those 6 months of sharp rally, Value* has done tremendously well. However, on a 2-year basis, it trails Growth by 12%.

The question is whether Value can keep performing and claw back the performance differential.

Academic studies tell us Growth outperforms in the following backdrop:

- Flat or downward sloping yield curves
- Market EPS growth fairly low or falling
- For small caps: narrower default spreads and high inflation

Let’s have a look at the recent data:

It looks like Bond Yields are a significant factor, which makes plenty of sense.

We are back to pre-crisis levels and even below mid-cycle averages. How much better can it get?

*These are the current numbers. They troughed in May and are up 5-6% since then.

Remarks:

- The yield curve suggests that growth should outperform again unless bond yields start increasing again. It is an inflation / deflation call once again.

- The default spreads have compressed a lot and suggest that further enhancement will be small and/or slow. Hence small caps should be relatively lagging.

- Earnings growth is slightly favouring Value as the market recovers from the EPS fall in 2008-2009. The October 2012 number is around the 2007 peak level. So the consensus thinks it will take 5 years to go back to previous levels which is consistent with moderate growth. The consensus is not forecasting a strong V shape on the S&P. We nevertheless need positive EPS revisions to continue to sustain the Value style and current reporting season is suggesting an uplift to 2009 numbers but moderate change to 2010 and 2011.

I believe the US 10Yr bond yields are still in a secular downtrend and they have finished with abnormal moves. Hence, it is now all about EPS prospects. I struggle to see them improving much in the medium term.

In conclusion, the EPS argument still favours Value slighlty but the other macro data tend to favour Growth.
I think I will still go with Growth for the next few months then.