Picking stocks has been a tough job for the past few years, and the situation hasn’t gotten easier in 2016. The S&P 500 posted its fifth straight month of positive returns in July, taking year-to-date returns to 8% at the end of the month. However, despite these relatively impressive gains equities have still underperformed gold, Treasuries, and credit this year.
Year-to-date gold has gained 27%, long-term Treasuries are up 18%, investment-grade credit has added 9%, and emerging market stocks are up 8% in local currency or 12% when converted back into dollars.
Equity gains are not limited to one particular sector or style. Indeed, during May of this year, Value as an investment style seem to be regaining popularity and several different groups of analysts all proclaimed that it was time to pile back into the strategy ahead of a major ‘Value rally’. Deutsche Bank, in particular, claimed that the value spread — the cash flow yield differential between the cheapest stocks (first quintile) and the market – had reached a level not seen since 2013-2014 offering investors a chance to buy into the wider equity market rally on the cheap:
“The value spread between the cheapest stocks and the market widened starting in March 2015 and continued through January 2016 on recurring growth scares, retracing 2/3 of the entire 2013-14 value tightening cycle. As growth fears receded in Q1, the spread has tightened, but remains well wide of cycle lows, with half of a typical value cycle tightening remaining.” — Deutsche Bank May 18 Asset Allocation Strategy report.
Value outperforms YTD but growth is catching up
The S&P 500 Value index has returned 9.1% year-to-date, outperforming the S&P 500 Growth index by 2.8% over the same period. But in recent months this trend has been flipped on its head. The S&P 500 Growth index has produced a return of 7.1% in the past three months compared 4.6% for the Value index. This trend only accelerated in July when the Russell 1000 Growth index beat the Russell 1000 Value index by 1.8% on a total return basis.
Another notable equity trend for July is the outperformance of low-quality stocks compared to high-quality equities. Low-quality stocks (S&P quality ratings of B or worse) beat high-quality stocks (B+ or higher) by 2.3% in July after trailing by 5% in the first half. The lowest quality stocks (S&P quality ratings of C and D) gained an average of 10.6%, their strongest month since January 2012.
Within small caps, low quality and risk performed the best as non-earners beat out earners, low ROE topped high ROE, and high beta outperformed low beta. As with the large caps, Growth outperformed Value in both small and mid-caps, but Value still leads for the year.