There is a narrowing of market leadership within global equity markets, and it clearly begins and ends with the U.S. in general and more specifically with growth-oriented stocks/indexes. U.S markets continued the steady climb higher (R3000 +3.5%), while many overseas markets, both developed (EAFE -1.9%) and emerging (EM -2.7%), declined during the last month. However, as mentioned above, market leadership is much narrower than the U.S. versus everyone else.
Equity markets are being led by companies exhibiting growth and not value characteristics, continuing a trend that has been in place for several years now. Is this trend sustainable and what are the implications for active managers versus passive benchmarks? In August, the Russell 3000 Growth Index produced a 5.5% return and it is now up 16.6% year-to-date. While growth was producing a robust return, the R3000 Value Index was up only 1.6% for the month and it has produced a much more modest 4.2% YTD return in 2018.
Historically, the small value index (R2000 Value) has bested large growth (R200) by 3.1% per annum for the last 20 years through August 2018. However, given the meaningful outperformance of both large-cap and growth during the last 5 years, this relationship has been flipped completely with large-growth outperforming small-value by 7% per annum during this time frame. A 3-year comparison also favors large growth by 5.1% per annum.
This concentrated outperformance by large growth has impacted active managers in the U.S. many of which have inherent biases to both smaller capitalization companies (build equal-weighted portfolios) and value (screen for price to something, such as book value, earnings, sales, enterprise value, free cash flow, etc.). We don’t believe that this concentration is good for the markets or it’s participants longer term and we believe it is time to consider rebalancing from large growth to small value and from passive to active at this time.