The Macro Forces Shaping the Growth vs. Value Rotation

Last week, we keyed into the growth vs. value rotation that has kicked off the year 2022 with a bang. Value’s rally and growth’s sell-off through the first two weeks of the year were historically significant and have added fuel to the fire in an already tumultuous environment headlined by macroeconomic conditions.

GROWTH AND VALUE AT HISTORIC LEVELS

Since our last update, the Growth and Value factors in the Axioma US 4 Medium Horizon (“AXUS”) risk model have slowed but have not changed direction quite yet. For example, from January 18th through the 27th, Growth declined by an additional 7 bps, and Value added 35 bps of return. As a result of those extended moves, the factors have been flagged as “Extremely Oversold” and “Extremely Overbought,” respectively.

The "Extremely Oversold" and "Extremely Overbought" designations derive from Omega Point's Normalized Return metric, which compares a factor's short-term performance (101 day) to its longer-term performance (252 day). The Normalized Return is expressed as a Z-Score to measure where a factor is currently trading relative to its historical mean.

Depending on the direction, a factor that reaches +/- 2 standard deviations is considered "Extremely Overbought" or "Extremely Oversold" and typically indicates a higher probability of that factor reverting toward its mean. The current situation marks only the fifth time since 2006 that Growth is stretched to two standard deviations below its mean, and the eighth time Value is stretched to two standard deviations above its mean.

We know that macroeconomic factors have been strong catalysts in driving the growth vs. value rotation, particularly the looming intervention from the FED to combat rising inflation. To cross-reference the conclusion that growth and value are historically stretched, we can look at the Vanguard Growth Index Fund (VUG) versus the Vanguard Value Index Fund (VTV) in the context of the Quant Insight macro dataset in Omega Point.

Quant Insight’s macro model uses macroeconomic factors to provide valuations of stocks, ETFs, and indices. While the broader market sell-off has resulted in both VUG and VTV’s market prices falling below Quant Insight’s valuations for the two ETFs, we see below that VUG is much cheaper from a macro perspective than its counterpart (VTV). Aside from the closing and re-opening phenomenon of 2020, the current valuation gap represents the most significant disparity we’ve seen since 2011.

Vanguard Growth Index Fund (VUG) vs. Vanguard Value Index Fund (VTV) Fair Value Percentage Gap

RATES AND RISK APPETITE PAVE THE PATH FORWARD

To understand the macro factors that power the relative trade-off between growth and value, we can observe the relative sensitivities of VUG vs. VTV in the Quant Insight dataset. From a Financial Conditions point-of-view, VUG has become increasingly negatively exposed to the USD 10Y Real Rate and FED Rate Expectations since the beginning of December. Although the relative sensitivity to FED Rate Expectations has reversed course a bit this week, these two factors combined represent an implied active return of -97 bps in the event of a one standard deviation upward move in both factors. In other words, growth stocks prefer lower rates and easier financial conditions relative to Value.

Vanguard Growth Index Fund (VUG) vs. Vanguard Value Index Fund (VTV) Macro Exposures

From a Risk Appetite perspective, we see a similar downward trend over the same period for the VIX, VDAX, and VXEEM, representing volatility benchmarks for the S&P 500, the Deutsche Boerse, and the CBOE Emerging Markets, respectively. As a result, growth stocks are becoming more heavily dependent on volatility subsiding and calming these "fear indices." While still averse to volatility, Value is far less susceptible to a sell-off during periods of high market turbulence.

Vanguard Growth Index Fund (VUG) vs. Vanguard Value Index Fund (VTV) Macro Exposures

However, for growth to come back into vogue and reverse the rotation we've seen year-to-date, we will need to see easier financial conditions and lower levels of volatility across markets unless there is a dramatic change in the sensitivities of stocks in each category to the macro factors that underlie these themes.

GROWTH AND VALUE REBELS

With that in mind, is it still worthwhile to look for growth or value stocks that go against the grain? It's not sufficient to paint with broad strokes. Are there growth stocks that benefit from the current macro environment and value stocks that it hinders? To get some high-level answers to these questions, we looked at the underlying stocks in the VUG and VTV ETFs to find what percentage have macro sensitivities that differ directionally from the aggregate sensitivities we saw above.

In the table below, the USD 10Y Real Rate and FED Rate Expectations factors measure Rates sensitivities, while the VIX, VDAX, and VXEEM factors measure Risk sensitivities.

We see that about one-third of the stocks in VUG benefit from rising rates, and a third of the stocks in VTV are adversely affected. Of course, neither growth nor value stocks particularly like heightened levels of volatility. Still, there are opportunities to find growth stocks that, in aggregate, are fine with the macro landscape we find ourselves in today and value stocks that might be in trouble.

As we continue to navigate the growth vs. value rotation, we will further explore security screening for macro opportunities and other actionable workflows like portfolio rebalancing and hedging to help managers better position themselves in a rare market environment. If you are interested in learning more, please don’t hesitate to reach out.

‍US & Global Market Summary

US Market: 01/24/22 - 01/28/22

• U.S. stocks rallied into the close Friday to wrap up a roller-coaster week with the Dow up 1.3% for the week and the S&P 500 added 0.8%, breaking a three-week losing streak. The Nasdaq Composite finished the week almost even at +0.01%.
• As expected, the Federal Open Market Committee indicated Wednesday that it likely soon raise interest rates for the first time in more than three years as part of a broader tightening of historically easy monetary policy.
• Economic data released on Friday showed a drop in consumer spending coupled with the lowest consumer sentiment reading in a decade.
• The Bureau of Economic Analysis reported Thursday that the economy grew by 5.7 percent in 2021, the fastest full-year clip since 1984.
• Cryptocurrencies plummeted with Bitcoin hovering below $38K, having shed ~40% of its value since its mid-November peak.
• Oil prices are close to seven-year highs as global energy markets react to a Russian troop buildup on the border with Ukraine.

Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• Profitability pushed upwards for a third straight week, dethroning three-time champ Value atop the U.S. leaderboard.
• Medium-Term Momentum finally put on jets following a longer-term trend downward where it flirted with breaking through the extremely oversold threshold.
• Value just missed a four-bagger atop the leaderboard but continued to move deeper into extremely overbought territory to finish the week at +2.43 SD above the mean.
• Growth seemed to stabilize a bit following its recent freefall as it sits on the cusp of leaving extremely oversold territory at -2.01 SD below the mean.
• Earnings Yield slip last week turns into a hard slide following a multi-month upward trend and finished at the bottom of this week’s leaderboard.
• U.S. Total Risk rose by 0.27% this week.

Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Exchange Rate Sensitivity continued to rocket upwards to trounce all factors for a second straight week and approach overbought status.
• Market Sensitivity was oversold just one month ago but kept up its impressive climb and secure the week’s runner-up spot.
• Value slowed its upward tear but still inched deeper into overbought terrain.
• Size continued to show weakness as it approaches extremely oversold status.
• Earnings Yield fell for the fifth consecutive week and crossed into negative terrain as it pushed aside recent laggard Growth to finish dead last in the global rankings.
• Global Total Risk rose 0.14% this week.

Regards,
Kevin