The Widening Growth/Value Gap

In a recent Financial Times Money Show podcast, editor Claer Barrett discusses the recent market rally, government stimulus, and the relationship between value and growth stock valuations with FT columnist Merryn Somerset Webb.

Here are key takeaways from Ms. Somerset Webb’s comments:

  • Investors should view the rally with caution: Those that had concerns about the market and valuation levels before the pandemic hit should be “particularly concerned about the areas that are very expensive,” with tech companies being a particular area of focus.
  • The gap between value and growth stock valuations has been widening for years, she said, noting: “People say it’s because the companies at the bottom are worse than they ever used to be. But that’s not true.” She explains that the “profit differential” between value and growth stocks is “roughly the same as it has always been and is not driven by some “previously unknown quality differential.”
  • History shows that the value and growth stock price differential consistently reverts back to a mean. She contends that we are now in the “early stages of the valuation gap beginning to close.”
  • Lower rates make investors more willing to channel money into a potential for long-term growth, which drives growth stock prices higher. But she adds that the recent surge of government stimulus and the sharp increase in the money supply makes valuations “completely irrelevant.”