Leaning into cyclical value could prove beneficial this year, but we wouldn’t suggest leaving growth stocks behind.

The long rivalry between growth and value investing styles hasn’t seemed like much of a contest over the past decade, with growth stocks showing dominant performance since the global financial crisis. In 2020, the pandemic accentuated this dichotomy as economic shocks tied to COVID-19 hurt many traditional and cyclical businesses, but fueled an acceleration in digital trends associated with large, fast-growing tech companies. The market reacted accordingly, reflecting these fundamentals as well as reduced interest rates, which tend to enhance the valuation of long-dated earnings. For the year, the Russell 1000 Growth returned 38.5%–or 36% more than the Russell 1000 Value Index, a difference that eclipses even the tech boom of the late 1990s.

Growth Has Outperformed Value in Recent Years

Relative Annual Return of the Russell Growth vs. Value Indices (Percentage Points)

IQ 1Q 2021

Source: BofA U.S. Equity. Data through December 2020. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

The continuation of growth stocks’ long-term strength has further recast the major indices, with fast-growing sectors such as technology and health care now accounting for far larger index weightings than those of 10 years ago (see display below). Performance has also been highly concentrated, with familiar names generating most of the standout performance. In fact, while the entire S&P 500 rose 18.4% last year, eliminating the top five performers would have yielded a return of just 6.8%, and the top 10 only 3.9%.1 As such, this relatively small collection of stocks has also increased its index weighting, with the largest five stocks representing 20% of the S&P 500 and 35% of the Russell 1000 Growth Index as of December 31, 2020.2

Growth Sectors Have Gained Share

Change in S&P 500 Sector Weightings: 2010 – 2020

IQ 1Q 2021

Source: Bloomberg, Neuberger Berman. Data as of December 31, 2020. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

As a result of this continued strength, the valuation multiples of growth stocks have become more extreme (see display below), even accounting for their relative stability during recent economic turmoil, and especially when viewed compared to the multiples of value stocks. Theoretically, this points to potential vulnerability, and the relative attractiveness of value. It also bears noting that prior to the past decade’s drought, value and growth stocks often exchanged leadership, with value actually coming out ahead over the long history of the market since 1929. However, more recent talk of such a rotation has often led to disappointment.

Growth vs. Value Price/Earnings Difference

IQ 1Q 2021

Source: FactSet, Neuberger Berman. Data through December 31, 2020. Two Standard Deviations represents 95% of all possible outcomes. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

What Could Be Different This Time?

The economy. In the current environment, we see potential for renewed strength in cyclical value shares likely driven by robust global recovery from dire levels, as economies benefit from reopening tied to the dissemination of vaccines, easy monetary policy and pent-up demand fueled by elevated savings rates. Historically, value stocks, which are particularly exposed to broader economic trends, have tended to benefit immediately following recessions—something that seems likely in this case (see display).

Value Led Following 14 of the Previous 14 Recessions

Relative Price Performance of the Fama-French Value Factor (High Book Value to Market Cap) vs. S&P 500 Post Recessions, 1929 – 2009

IQ 1Q 2021

Source: BofA U.S. Equity & Quant Strategy, Dartmouth University data library, Bloomberg. Data as of July 2020. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

Investor Positioning. Also compelling to us is how many investors have taken a stake in the growth story. Indeed, portfolio weightings in growth categories such as Communication Services have reached near-record levels, while value segments like Financials seem to have become an afterthought—not only for retail investors, who tend to be relatively momentum-driven, but for many professional managers as well. Historically, investors have tended to gravitate toward growth-oriented companies when profit and earnings growth are scarce. However, when earnings has broadened out, they have often moved toward value—something that we think could happen in coming months.

Near-Record Overweight in Growth, Underweight in Value

Long-Only Positioning in Communication Services vs. Financials Relative to S&P 500

IQ 1Q 2021

Source: BofA U.S. Equity and Quant Strategy, FactSet. Data through June 2020. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

Legal/regulatory pressures. Although the pandemic has enabled large, well-positioned players to heighten their dominance of areas such as connectivity and digital retail, it has also brought renewed scrutiny from legislators and regulators, who are assessing the largest companies based on antitrust and taxes, as well as liability for fraudulent social media that has contributed to U.S. political turmoil. It’s unclear whether current scrutiny will translate into meaningful action, but it could add to uncertainty around some key growth players.

Valuations. Although a widening out of differences in valuation between growth and value is unlikely to produce change in market behavior without a catalyst, the current spread has become so significant (see Growth vs. Value Price/Earnings Difference, above) that a meaningful shift in economic fundamentals could have a major impact on their relative return outlooks.

Opportunities and Caveats

Where could we find opportunities in value? Although value generally seems more appealing than growth on a relative basis, our Asset Allocation Committee favors smaller-cap U.S. names, which are generally more exposed to economic recovery than larger counterparts, as well as non-U.S. developed and, in particular, emerging market equities, which tend to be weighted more toward cyclical sectors such as commodities and have been particularly beaten down over the course of the pandemic. Across asset classes, the analysis will likely be case-by-case, with value stocks within various value sectors such as industrials or financials meriting closer attention.

Cyclical Emphasis Overseas

IQ 1Q 2021

Source: FactSet, Neuberger Berman. Data as of December 31, 2020. Cyclical Sectors: Consumer Discretionary, Financials, Real Estate, Industrials, Materials. Defensive Sectors: Consumer Staples, Energy, Health Care, Utilities. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.

Still, there are caveats. For example, it’s possible that vaccine distribution could be slower than anticipated, thus potentially limiting the pace of economic recovery. Moreover, value stocks can be more difficult to research, so managers need to look carefully to avoid “value traps” where share prices, while low, do not fully reflect fundamental weakness.

We would not say that the growth story is over by any means. In past markets, surges in tech and other key areas have often been driven by excessive optimism about the future. In 2020, we believe growth names advanced largely by virtue of their actual results during the pandemic. Current valuations may carry some excess, but themes including next-generation connectivity, e-commerce, automation and telehealth are likely to endure and provide opportunities moving forward—and could help to reassert growth leadership once the potential rotation we are contemplating works its way out.

As part of our asset allocation approach, we generally favor a “barbelled” weighting of value versus growth, in order to avoid concentrating risk should broader fundamentals move one way or the other. However, where feasible, we believe that leaning into value through tactical portfolio tilts could potentially prove beneficial over the coming year.