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Is There a Bubble in Growth Stocks?

May 21, 2020 By Jeremy Jones, CFA

By microstock3D @ Shutterstock.com

Growth stocks are beating value stocks by the widest margin since the dotcom bubble. The top 5 S&P 500 stocks (all growth-oriented technology companies) now account for over 20% of the index—the highest weighting for the Top 5 in the S&P 500 in at least the last three decades. What’s more, for the first time in a decade, a net 20% of fund managers are expecting growth stocks to outperform value stocks.

Sounds like a good time to lean into value especially those value stocks that pay and increase their dividends regularly.

The Wall Street Journal’s Akane Otani reports:

Growth stocks are typically companies that promise to deliver faster-than-average profit growth in the future—something that investors say has been particularly attractive in the current economic downturn. Value stocks, on the other hand, typically trade at a low multiple of their book value.

After rallying the past month, the Russell 1000 Growth Index is up 1.2% for the year, while the Russell 1000 Value Index is down 21%. If the year were to end today, the former index would have outperformed the latter by the most since 1999, according to Dow Jones Market Data.

The divergence between the two categories of stocks is so vast that some analysts and investors question how much longer it can last.

Conventional investment theory suggests value stocks, which include banks, oil companies and industrial conglomerates, start to do better than growth stocks when the economy begins to recover from a downturn. That is because many value stocks are particularly sensitive to ebbs and flows of economic activity. In theory, they should be among the biggest beneficiaries of a recovery.

“In our view, the extreme current valuation gap between the most expensive and least expensive stocks will most likely be closed when an improving economic environment causes the low valuation stocks to ‘catch up’ to the current market leaders,” Goldman Sachs Group Inc.’s chief U.S. equity strategist, David Kostin, wrote in a note.

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Jeremy Jones, CFA
Jeremy Jones, CFA, CFP® is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Richard C. Young & Co., Ltd. was ranked #5 in CNBC's 2021 Financial Advisor Top 100. Jeremy is also a contributing editor of youngresearch.com.
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