At the beginning of June, the Financial Times published a damning assessment of value’s performance in 2017. The newspaper noted that the top ten performing stocks of the S&P 500, most of which are in the tech industry, accounted for almost half the S&P 500’s to-date gain of 7.7%. In contrast, the S&P 500 value index had only eked out a 2% gain for the year to the date of publication. Put simply, during the first six months of 2017; growth stocks smashed value.  Despite this outperformance, analysts at Jefferies believe that growth stocks earnings growth will lead to outsized returns for investors going forward, as growth is still very cheap versus value despite outperforming year-to-date.

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Growth Stocks Earnings Growth Is Robust

Growth stocks have been able to justify their recent strong performance due to the fact that earnings growth has kept pace with valuations. Even though the market’s average valuation is high, growth stocks can justify the higher valuation because they’ve actually been able to produce earnings growth. On the other hand, value stocks have struggled to grow earnings.

Growth Stocks Earnings Growth growth stocks earnings growth

Not only is growth stocks earnings growth putting it in a fundamentally better performance than value, but the style also trades at a more attractive relative valuation according to Jefferies’ analysis. The chart below shows that relative to value, growth is trading above the 2008 lows, but still well below the historical average.

Growth Stocks Earnings Growth

Growth is outperforming value, and large caps are growing faster than small caps at the most rapid rate since the Great Financial Crisis. According Jefferies analyst Steven DeSanctis, the earnings growth difference between small and big business is currently 10.4%, which "keeps us cautious” because the combination of a weaker dollar, improved global growth, weakness in consumer discretionary and energy in addition to just lower earnings results amount to "death by 1000 cuts," for small caps. That is why Jefferies continues to see large outperforming small.

Still, DeSanctis does not think that the earnings gap will grow much wider:

“Canary in the coal mine? Just may be. So after all of our testing the main takeaway regarding the difference in earnings and sales is that the large caps simply had a much better quarter than the small caps. The large difference can't last too long in our opinion, and thus the issue is whether or not large gets worse or small gets better. We think large is over-earning thanks to the weaker dollar and better global growth and the fact that the US economy is not as strong as the GDP number implies. Single-digit earnings growth does not support where multiples are today.”