Driven by weakness in FANG stocks, the tech-heavy Nasdaq index closed 1.4% lower on 30 July, its third straight daily decline. Tech weakness has been the driver for a 4% outperformance of US value over growth stocks over the three trading days to 30 July, making this the most aggressive rotation out of growth stocks in more than nine years.
Lower earnings growth guidance from Facebook and weaker-than-expected subscriber growth from Netflix have been significant factors behind the declines. But, while these company-specific issues might suggest the growth stock underperformance may be short-lived, we see a number of factors that suggest the rotation could persist:
- Valuations for US growth stocks are at the highest levels relative to value stocks since 2006 based on Russell 1000 index companies. As high profile companies have disappointed on earnings growth, valuations have come back into focus, and suggest room for further growth underperformance.
- The broad outlook for tech remains supportive: enterprise IT spending appears robust and will benefit around 60% of the sector by market cap. But this favourable outlook is already reflected in sector valuations. The sector’s price/earnings ratio is 13% higher than the overall market, in line with its long-term average.
- Slower growth in Europe and emerging markets in the first half prompted investors to rotate out of value stocks such as financials and industrials into growth stocks. Recently there are signs that Europe is recovering and China has implemented stimulus measures. If global growth remains resilient, as we expect, value stocks should benefit.
Overall, we remain neutral on the US tech sector, but believe there will be further underperformance of growth stocks relative to value. There are risks of periodic setbacks to value out-performance, should trade tensions escalate causing concerns over global growth.
Valuations for growth stocks are the highest in years
Relative P/E Russell 1000 Growth vs Value