How much longer can Value outperform Growth in US large cap equities? One way to answer that question is through the lens of sector performance. Here’s why:
- The largest piece of the S&P 500 Value Index, at 22% versus 13% for the S&P 500.
- This group has handily outperformed the S&P 500 over the last month, +5.8% versus +2.8%.
- An overweight in S&P 500 Growth, with a 26% weight versus 22% for the S&P 500.
- Tech has been a modest underperformer over the last month, only up 2.5%.
- The other swing factor between Growth (3% weight) and Value (7%) because it is 5% of the S&P 500.
- Energy is the best performing S&P sector over the last month, up 6.0%.
One way to assess how markets think about future price performance for these groups is to look at the Implied Volatilities (IVs) imbedded in options prices. This is the same math as the CBOE VIX Index, which measures the market’s assessment of future price risk for the S&P 500. A low (sub 14) VIX means markets don’t expect dramatic near term price movements. A high (+26) VIX implies greater than average uncertainty about stock prices. Future price performance is, of course, negatively correlated to movements in the VIX.
Here’s how recent trends in Implied Volatilities look for these 3 sectors:
- The “VIX of” this group is down 20% over the last month, in line with overall market trends.
- On an absolute basis, the IV of Financials is 15.6, much closer to its 1-year lows of 12.3 than recent highs of 25 in August.
Takeaway: the proverbial “wall of worry” that has plagued Financials is a lot smaller now than a month ago, thanks to the recent backup in long-term interest rates. To our thinking, this limits further upside.
- The “VIX of” Tech also declined over the last month, by 21%.
- Unlike Financials, however, the IV here of 17.7 is still well above 1-year lows of 11.3.
Takeaway: options markets are pricing greater incremental risk in the Tech sector just now, likely due to its recent underperformance. Just as an elevated VIX is often a buy signal for the S&P 500, a higher IV should be a positive for Tech stocks’ future performance.
- Unlike Financials and Tech, the “VIX of” the Energy sector is only down 11% over the last month despite its dramatic outperformance.
- The absolute level here is 20.4, well above both other groups and also the 2019 range of 15-20.
Takeaway: there’s still enough risk priced into options markets to make Energy look attractive by this measure. Much of that is due to the uncertainty over commodity prices, but Energy’s current S&P weight is so far below historical norms that some reversion to a longer-run mean (call that 7-10%) would not be surprising.
The bottom line here: the contest between Growth and Value is really a tug of war between Tech and Financials, and options pricing implies more upside for the former. Energy may continue to work, especially if Middle East tensions continue to rise, but it would need to replicate its recent performance for many more months to swing the needle in favor of Value.