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On February 19, the S&P 500 stock index closed at an all-time high of 3,386.  Leading the index to all-time highs were growth stocks, companies that achieve higher than average earnings growth due to unique products or services whose demand remains strong even during times of relatively slow overall economic growth. Some of the most prominent among growth stock leadership were information technology and consumer discretionary giants Microsoft, Apple, Amazon, Facebook, Alphabet (Google) and Visa. Their ability to achieve above-average earnings growth results in investors willing to award them a higher valuation as measured by price-to-earnings ratios and other metrics.
This contrasts with value stocks, companies that trade at a lower valuation and often pay higher dividend yields in more mature sectors including financials, heath care, utilities, consumer staples and energy. Some prominent value stocks include: Bank of America, Exxon Mobil, Verizon and Johnson & Johnson.

Exhibit I illustrates the relative performance of growth stocks compared to value stocks as measured by the S&P 500 Growth index (SGX) and the S&P 500 Value index (SVX).
Exhibit I

This ratio analysis divides the price of the growth index by the value index and plots that ratio over the last five years, which is depicted by the red line. The green and blue lines smooth the ratio over 50 and 200 days, respectively. The upward slope of the trend lines suggest that growth stocks have been out-performing value stocks for most of the past five years. In fact, over this five-year period growth stocks have experienced a price increase of 72% while value stocks have increased only 16%.

Interestingly, the rate of growth stock relative outperformance accelerated during 2020 as the COVID-19 crisis impacted the stock market. Even as the S&P 500 declined 34% from the February 19 peak to the March 23 low, the S&P 500 growth index performed better by declining 31% while the S&P 500 value index declined 37%. It would have been reasonable to expect growth stocks, which had led the market to all-time highs, to sell off more than the overall market due to their higher valuations, much like they did in the 2000-2002 bear market or the 20% sell-off in the 4th quarter of 2018.

However, the unique impacts of the COVID-19 crisis were quickly ascertained by investors, identifying the sectors, industries and companies impacted most negatively as well as positively. While all sectors had negative returns during the 34% decline from 02/19/2020 – 03/23/2020, Exhibit II illustrates the wide differences in performance among the 11 sectors that comprise the S&P 500 stock index.
Exhibit II

As illustrated above, traditional value sectors: financials and energy, were hit hardest. Financials were impacted by lower interest rates as investors sought the safety of high-quality fixed income assets and the Federal Reserve quickly brought the Federal Funds rate to near zero. Investors became concerned about the impact of lower rates on banks’ net interest margins and the slowing economy’s effect on loan credit quality. Energy prices collapsed as transportation demand came to a halt and identifying storage locations for ongoing oil supply became problematic.

Some value sectors weathered the storm better. Defensive value sectors including consumer staples and healthcare were the least damaged sectors as demand increased for food, sanitization products, medical supplies and other daily staples.

One of the bigger surprises has been the extent to which growth sectors: information technology, consumer discretionary and the growth industries within communication services performed relatively well during these unprecedented times. While you would expect the consumer discretionary sector to be negatively impacted as jobless claims soared, and certain industries including restaurants, hotels and autos were among the most damaged, other retailers have fared relatively well.Amazon, the giant in the sector, declined only 12% during the 34% market sell-off and is now trading well above where it traded at the February 19 market highs as investors factored in the obvious benefits of online shopping during the pandemic. In addition to other online retailers, Home Depot and Lowes have seen strong demand as homebound consumers focus on staying put and improving their homes.

Several technology themes have seen increased demand as more employees work and shop from home. Computer hardware, software and cloud computing, which enable employees to complete work and communicate from home, have seen increased demand and have benefited growth companies including Microsoft, Apple, Adobe and Salesforce. Increased online shopping and concerns about virus transmission via cash have accelerated adoption of digital payment, benefiting growth companies Visa and PayPal, among others.  In a socially distanced world, increased use of social media, web-search and online gaming has demonstrated the appeal of Facebook, Google and computer gaming stock Activision Blizzard.

Have growth stocks gone too far?

The question arises as to whether the performance of COVID-19 themed stocks and growth stocks in general have gone too far. As we saw in Exhibit I, the recent outperformance of growth stocks has been dramatic and the disparity in performance between growth and value stocks is at historically extreme levels. Technology stocks, as measured by the 14-day relative strength index (RSI), are not technically overbought; however, the current RSI level of 64 is very close to the 70-level that is the classic overbought definition.

Now with economies opening back up and overall virus data improving, some of the hardest hit cyclical and value stocks are coming off their lows and many of the previously outperforming stocks have paused or moderated their ascents. As virus-related concerns wane, focus has returned to other risks including deteriorating trade relations and tension with China, social unrest, technology giant monopolies, presidential disputes with social media and overall political risks as we edge closer to the November election.

COVID-19 has demonstrated the significance of technology including work-from-home, online shopping, digital payments, social media, etc. Many of these themes will be impactful beyond the current crisis, but prices of these growth stocks have likely gotten ahead of themselves in the short term. Likewise, the wide disparity in performance between growth and value stocks presents short-term opportunities in some of the hardest hit value sectors which will likely experience some reversion to the mean. Though the trend of outperformance of growth stocks relative to value stocks will likely continue over the longer term, especially if overall economic growth remains low, COVID-19’s recent impact on the market has presented some short-term opportunities among hard hit value stocks.