1.Growth Continues To Crush Value This Year For US Equity Factors
The sharp swings in the stock market in recent weeks haven’t dented the year-to-date performance edge that’s prevailed for large- and small-cap growth stocks in the US over their value counterparts, based on a set of exchange-traded funds through yesterday’s close (Nov. 7).
Large-cap growth still holds the lead for The Capital Spectator’s set of US equity factor ETFs so far in 2018. The iShares S&P 500 Growth (IVW) is up a strong 11.5% year to date. Running slightly behind in second place is iShares S&P Small-Cap 600 Growth (IJT), which is ahead by 10.9% so far in 2018.
Value, by comparison, is far behind in this year’s equity factor horse race. Dead last for year-to-date results at the moment: iShares S&P Mid-Cap 400 Value (IJJ), currently posting a slight 1.3 gain. The second-weakest performance this year: iShares S&P 500 Value (IVE), which is ahead by 1.5%.
Meanwhile, the broad market this year is up 6.7%, based on the SPDR S&P 500 (SPY).
We can therefore expect the dollar super-cycle to come to a close over the next few years. Here are 4 fundamental factors, not mutually exclusive, that I’ll be watching for:
Narrower growth differentials between the U.S. and other countries.The U.S. economy is much further along in the business cycle than other developed markets are, its labor market is much tighter, and inflation is much closer to the central bank’s target, which in the U.S. is 2%. Since economic growth normally slows late in the cycle, current growth differentials between the U.S. and other economies are expected to shrink. The next slowdown in the U.S. may be exacerbated when the recent fiscal stimulus wears off. We estimate that the stimulus, injected through the tax cuts and spending bill enacted at the beginning of the year, will deliver an extra push to U.S. economic growth of about 40 basis points this year and next.
Higher U.S. bond yields, but narrowing interest rate differentials. Higher bond yields in the U.S. today imply depreciation in the U.S. dollar relative to other major currencies in the future. This market expectation may come to pass in the current global monetary cycle as the gap in rates between the U.S. and other major markets narrows. The Fed may stop raising rates as soon as 2019 while other central banks (notably the European Central Bank and the Bank of England) continue to play catch-up.
Higher inflation in the U.S.Higher inflation in the U.S. relative to other developed markets could put downward pressure on the nominal U.S. dollar exchange rate.
A larger U.S. trade deficit.For all the noise about tariffs and trade deficits, the natural way for trade imbalances to correct over time is through market-driven currency adjustments. Widening U.S. trade deficits translate into higher demand for foreign currency (to pay for the additional imports), which exerts downward pressure on the dollar. The trade deficits themselves are caused in part by rising government budget shortfalls, which spill over to more foreign purchases of U.S. debt, and in part by strong U.S. consumer spending, which, bolstered by tax cuts, results in more purchases of imported goods, given that they constitute about 18% of the typical consumer basket.
On a recent episode of his show, Behind the Markets, WisdomTree’s Jeremy Schwartz made a comment about a stat from one of Jeremy Seigel’s books. He discussed how in real terms, bonds in the U.S. have actually experienced a much longer bear market than anything witnessed in the stock market.
This makes sense when you realize the biggest risk for stock market investors is generally a crash while the biggest risk for bond market investors is sky-high inflation.
I decided to run the numbers to put some more meat on the bones of this one to gauge the length of bear markets in both stocks and bonds on an after-inflation basis.
This is the historical real drawdown chart for the S&P 500:
I didn’t know which route to choose for a bond proxy so I decided to look at both 5-year treasuries and long-term treasuries. Here’s the chart for the 5-year bond:
And these were the drawdowns for long-term bonds:
Here’s what the stats look like for the longest bear markets for each since 1926:1