Rising interest rates in response to ever-heightening inflation was a dominant theme driving stock market performance in 2022. Within that environment, value stocks enjoyed a strong relative performance advantage over growth stocks. This is similar to what played out during the 1970s, another period when value saw significant outperformance over growth. With interest rates remaining high, it is notable that growth has managed to outperform value this year in the U.S.
The blowout earnings quarter posted by NVIDIA on May 24th, amplified investor focus on artificial intelligence and its potential impact on the future of everything, pushing already strong returns higher for many mega-cap companies exposed to the space. While naysayers will cite this catalyst as the primary reason for positive stock market returns in 2023, since the start of the year the Carson Investment Team has pointed to a resilient U.S. economy bolstered by a strong consumer and falling inflation as a major impetus for stock gains.
Regardless, given the mega-cap names’ size and thus their corresponding impact on index performance, it is clear that the price gains have benefited U.S. equity benchmarks this year, which in turn has led to greater index concentration. This was highlighted in July when the Nasdaq 100 had only its third special rebalancing in its history. Prior to the rebalancing at the end of June, the top ten weighted stocks made up nearly 60% of the index. The rebalancing reduced the weight of the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla) by 12%, bringing the weight of the top ten back below 50%.
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The impact of mega-cap stocks is even more pronounced when comparing the performance of growth versus value this year. In the U.S., growth stocks, as measured by MSCI Indices, have outperformed value stocks this year by nearly 30% through the end of September.
Absent this mega-cap stock effect, how has growth performed versus value outside of the U.S.? Well, it turns out the reverse is true in other parts of the world. In Europe, value stocks recently surpassed growth stocks in year-to-date performance. In Japan, the difference has been much more pronounced with value stocks strongly outperforming their growth counterparts.
| Index | YTD RETURN AS OF 9/30/2023 (Local Currency) |
| MSCI USA GROWTH INDEX | 29.1% |
| MSCI USA VALUE INDEX | -0.6% |
| MSCI EUROPE GROWTH INDEX | 7.7% |
| MSCI EUROPE VALUE INDEX | 11.3% |
| MSCI JAPAN GROWTH INDEX | 18.0% |
| MSCI JAPAN VALUE INDEX | 34.0% |
Source: MSCI, Bloomberg
Why the differences? Using MSCI indices exclusively for all the comparisons here should eliminate any methodology differences that can occur when comparing benchmark returns. (For example, growth outperformance is less than half that of MSCI when using S&P’s version of value and growth stocks within the S&P 500 Index.)
Could interest rate policy differences be playing a part? As we pointed out earlier, higher interest rates can favor value. Value stocks tend to be more mature businesses and typically offer nearer-term cash flows, while the projected cash flows of growth stocks tend to be weighted further out into the future. Higher interest rates are typically negative for growth stock valuations as future cash flows get discounted at a higher rate.
In the U.S., as the year has progressed, investors have come to the realization that interest rates will most likely be higher for longer. While inflation has been falling, it still remains above the Fed’s target of 2%, and current interest rates have yet to contract economic growth in a way that would cause the Fed to cut rates in the near-term. The current view of the Carson Investment Team is for no rate cuts by the Fed this year. To date, growth stocks have held up well in this higher interest rate environment.
In Europe, the European Central Bank’s (ECB) policy closely resembles the Fed’s. The ECB recently raised rates for a 10th straight time to 4.0%. That is the highest level since the euro currency was launched in 1999. The ECB also raised their inflation forecasts for next year while reducing their growth forecasts for both 2023 and 2024. Inflation is not expected to get to the target rate of 2% until 2025. While the ECB did signal that they are most likely done raising rates for now, it still seems like a higher for longer scenario, similar to the U.S.
In Japan, in contrast to U.S. and European central banks, the Bank of Japan (BOJ) has maintained its ultra-loose monetary policy despite inflation running above their 2% target. While saying they are focusing on bringing inflation down, BOJ policymakers remain unconvinced that higher prices are being caused by a solid pick-up in economic activity. As such, the short-term interest rate target remained at -0.1%. So, despite one region having a similar interest rate policy to the U.S. (Europe) and another one having a different interest rate policy (Japan), value has outperformed growth in both regions.
Changes in style leadership can be difficult to predict as macro drivers that can benefit/disadvantage either style are notoriously hard to forecast. However, it seems clear that the performance of the AI-exposed mega-cap names has the potential to heavily influence the growth versus value debate in the U.S. Thus, at least in the near-term, macro environments that may have traditionally favored value over growth may not always hold.
Could this impact continue to be more dramatic in the U.S. than in other parts of the world? Certainly, the large size of many of the U.S. mega-cap companies, and their impact on domestic benchmarks is likely to continue for some time. But just as importantly, the characteristics of these companies plays a part.
We at the Carson Investment Team believe that U.S. AI firms will have a competitive advantage going forward versus their international counterparts. Not just within the mega-cap names, but throughout the market cap spectrum. Keep an eye out for future research from our team detailing our reasoning along with other key factors investors should consider when investing in the AI space.
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