Is it the turn for value stocks after the explosive rise of technology growth stocks this year?

If tonight's remarks by the Chairman of the Federal Reserve cause US bond yields to rise again, growth stocks may be affected, providing investors with another reason to consider a shift towards value stocks, as proposed by Kevin DiCiurcio's Vanguard Capital Market Model Research Team.

Value stocks are defined as stocks with relatively low stock prices compared to book values, low expected and historical growth rates, and relatively high dividend yields.

Value vs. Growth

It is crucial to note that Vanguard states that the relationship between value and growth is currently at an extreme level, similar to the situation in 2020.

DiCiurcio says, "Now, as in the past, investors are generally very enthusiastic about growth stocks, especially in the technology sector, while interest in value stocks, including financial, industrial, and healthcare companies, seems limited."

Such extreme situations often provide opportunities for contrarian investments.

The chart below shows Vanguard's estimate of the fair value of value stocks relative to growth stocks.

Vanguard states that when the historical actual ratio exceeds the upper limit of its estimated fair value range, there seems to be a greater opportunity for growth stocks to outperform the market. When this ratio is below the lower limit of the range, there seems to be a greater opportunity for value stocks.

The three examples of extreme valuations in the chart illustrate this point. After being overvalued in 1993, value stocks underperformed growth stocks by 8 percentage points over the following three years.

However, during the technology stock bubble in 2000, value stocks were severely undervalued, and in the following year, value stocks outperformed growth stocks by 59 percentage points until reaching fair value.

Similarly, another undervaluation of value stocks in 2020 resulted in value stocks outperforming growth stocks by 46 percentage points in approximately 20 months.

The better the economy, the more value stocks can outperform the market

Vanguard states that the relative performance of the value index is once again significantly lagging behind: "For example, as of July 31 this year, the Russell 3000 Growth Index had a return rate of 32%, more than three times the 9% return rate of the Russell 3000 Value Index."

Furthermore, DiCiurcio says that the market performance during more than a dozen business cycles in the United States since 1980 indicates,

DiCiurcio states, "Considering relative valuation and economic conditions, increasing holdings of value stocks may help offset the expected lower overall market return rate over the next 10 years."