Investors should be careful of paying too much attention to established narratives in markets, says AJ Bell’s Russ Mould, who warned that the outlook for value stocks could change if the economic backdrop improves. 
Investment director Mould (pictured) said growthier technology stocks have come under increased scrutiny over the past week following a sell-off in equity markets.
He said: “Warren Buffett once noted that ‘A pack of lemmings looks like a bunch of rugged industrialists compared with Wall Street when it gets a concept in its teeth’.
“And those investors who piled into tech stocks must now ask themselves why they were buying and what they should do after three days of sharp falls.”
Mould said if investors were buying companies such as Facebook, Alphabet, Amazon, Apple, Netflix and Microsoft (FAANM) out of conviction for their dominant market positions, shrewd management, strong finances and future cash flows, then they may want to buy the dips.
“This temptation to run with the narratives that technology stocks are relatively immune to the pandemic and worth premium valuations because of the relative scarcity of consistent earnings growth right now is quite understandable,” he said.
“But there remains the danger that neither narrative is particularly new and is therefore at least partly priced in to technology stocks’ valuations.”
And narratives are not always what they appear to be, said Mould, highlighting the performance of the growth and value styles in recent years.
“Just look at how ‘growth’ stocks in the US have wiped the floor with ‘value’ stocks over the past decade and since 2017 in particular,” he noted.
Looking at the performance of the Invesco QQQ Trust – an exchange-traded fund (ETF) that tracks the Nasdaq 100 – and the iShares Russell 2000 Value ETF – which tracks the performance of around 1,400 US small-cap, value stocks – shows how a narrative such as ‘growth always outperforms value’ doesn’t always tell the full story.
Performance of ETFs over 10yrs
Source: Refinitiv data
“Since January 2010, the iShares Russell 2000 Value ETF is up by 124 per cent in capital terms, for a compound annual return of 7.8 per cent – so it is hard to argue that ‘value’ has ‘failed’ as a strategy,” he said.
“What is clear is that ‘growth’ has simply done so much better, offering a 490 per cent return, or a compound annual growth rate of 18 per cent, as benchmarked by the Invesco QQQ Trust.
“The performance gap between the two stands at a decade high.”
However, the AJ Bell investment director said it may surprise less experienced investors to learn that “the last decade’s stellar outperformance from growth has only just begun to cancel out the prior decade’s period of marked underperformance relative to value”.
As the below chart shows, the Invesco QQQ Trust has only just overtaken the iShares Russell 2000 Value ETF, using the latter’s 2000 launch date, having endured a more challenging environment for the growth style in the 2000s.
Performance of ETFs over 20yrs
Source: Refinitiv data
Mould explained: “That miserable 10-year showing followed the bursting of the tech, media and telecoms (TMT) bubble, so investors in tech and growth stocks now need to ask themselves whether they should fear a repeat.”
The investment director said current valuations alone are never a catalyst for out- or underperformance but are rather “the single biggest determinant” of long-term returns.
“If tech earnings keep growing and surprising on the upside, if interest rates stay low, if inflation stays subdued and the FAAANM stocks use the combination of product innovation and acquisitions to maintain and even deepen their powerful competitive advantages, then many investors will be tempted to dismiss valuation as an irrelevance,” he continued.
However, such stocks could be in trouble, according to Mould, if regulatory scrutiny increases, if earnings disappoint or if the wider economy begins accelerating and inflation picks up.
“None seem likely now but that it why ‘growth’ has done so well relative to ‘value’,” he said.
Should a Covid-19 vaccine be quickly and successfully developed and distributed then growth stocks seen as ‘immune’ may seem less worthy of a premium valuation, the AJ Bell investment director said. Although such a prospect now seems some way off.
And if the global economy and inflation continue to pick up, premium multiples for growth stocks may seem less attractive if rapid earnings can be acquired more cheaply in “downtrodden value, cyclical plays”, added Mould.
A rise in inflation could be a potential bellwether for value stocks, in that it might force government bond yields higher if central banks decide to raise interest rates to rein it in.
“Prior periods of rising 10-year US Treasury yields have coincided with attempted rallies in ‘value’ names,” noted Mould. “So perhaps a return to economic growth and inflation could be the trigger for a sustained period of underperformance from ‘growth’ and ‘tech’ stocks relative to value ones.”