Economists Get it Wrong. But Actually Help Predict Value’s Dominance Over Growth
By Dr. Leila Heckman, PhD, October 7, 2020
Who’d have thunk getting it wrong could lead to better investment outcomes? Our latest research identifies how economists’ forecasts, while often wrong, are actually linked to a standout predictive indicator of Value’s future outperformance over Growth.
Several months ago, I published a research note “Value Conquers Growth Coming Out of a Recession.” This analysis tried to answer the question whether Value or Growth tended to do better as the U.S. recovered from a recession. Since 1979, using the 3-month change in the ISM’s Manufacturing Purchasing Managers Index (PMI) index of 10% or greater as a signal for when to start measuring performance of the Russell Value and Growth Indexes as the US economy came out of a recession, I found the Russell Value Index outperformed the Russell Growth Index at the end of 4 out of the 5 recessions1. The only exception was during the aftermath of the oil shock led recession of 07/90 - 03/91. The average outperformance of the Russell Value Index over the Russell Growth Index over the 5 recessions was 4.8% twelve months post recession’s end.
1For the recession of 07/90 – 3/91, 3-month PMI change of 9.1% was used.
Rather than just restricting the analysis to recession, I recently extended the analysis to look at what other indicators might help in making the decision of whether Value might do better than Growth (or vice versa Growth might do better than Value) overall– not just coming out of recessions.
Chart 1 below measures the performance of the Russell Growth vs Value since 1980. The blue line measures Russell Growth Index divided by the Russell Value Index and the grey lines the cumulative 12-month return differential each month between the Growth and the Value indexes. As can be seen from the chart, Growth has done better than Value especially during the two peaks: one around 1999/2000 and the other starting around 2010.
Source: Russell Indexes, Bloomberg, Heckman Global Advisors
Chart 2 shows the correlations of various indicators with the forward 1-month, 6-month, and 12-month outperformance of Russell Value vs. Russell Growth. As can be seen from the chart, there are several indicators which have a positive correlation with the outperformance of Value over Growth and confirm the earlier study on the 3-month change in the PMI coming out of recessions.
The strongest indicator is GDP Forecast for Next Year. We have been collecting data on next year’s consensus GDP forecasts since 1990. It is always positive (economist are always optimists about next year), but there is some variation in the data. The average is 2.6% so if the GDP forecast for next year is higher than 2.6%, it tends to be relatively good for Value. As of the beginning of September, next year’s GDP forecast was 3.7%.
The next strongest indicator is Citi’s Economic Surprise Index.
“The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises (actual releases vs. Bloomberg survey median). A positive reading of the Economic Surprise Index suggests that economic releases have on balance [been] beating consensus. The indices are calculated daily in a rolling 3-month window.”
Again, when Citi’s Economic Surprise Index is higher than average (-2%), returns tend to be better for Value. As of September 18, Citi’s Economic Surprise Index was 172.5.
The third strongest indicator is Current Year Earnings Growth Forecast. We have also been collecting this data since December 1987 – aggregating from bottom-up earnings estimates for all companies in the MSCI US Index. The long-term average Current Year Earnings Growth Forecast is 11% so if the earning forecast is higher than 11%, it tends to be relatively good for Value. However, as of the beginning of September, the Current Year Earnings Forecast is currently at -16% which is below the average of 11%.
Chart 2: Correlation between Indicator and Relative Returns of Russel Value and Russel Growth
* Stats in 2003
The fourth strongest indicator is the 3-Month Change in the PMI which I used before for the analysis on recessions. When the 3-Month Change in the PMI is higher than average, it tends to be better for Value. The average is 0%, so if the 3-month change in the PMI is higher than 0%, it tends to be relatively better for Value. As of the beginning of September, the 3-Month Change in the PMI was over 30%.
Chart 3 shows the correlations of the future 1-month, 6-month, and 12-month out-/under-performance of Value vs. Growth with the trailing 1-month, 6-month, and 12-month out-/under-performance of Value vs. Growth. As can be seen from the chart, the strongest predictor for 6 months out-/under-performance and the 1 month out-/under-performance is the 6 months trailing out-/under-performance. There is some persistence to the Value vs. Growth performance. 12-month trailing out-/under-performance has the weakest correlation.
Source: Russell Indexes, Heckman Global Advisors
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