Recent Value/Growth cycles around the world have extended much longer than they have historically

“Thru the cycle” is a common phrase in the investment world, but what does it mean? How long is a cycle? Often, a specific length of time is used as an easy way to define a cycle. At the very least, it is assumed that after a certain number of years, say three or five, a given cycle will have completed. When Abraham Lincoln was asked, “How long should a man’s legs be?” he responded that they should be long enough to reach the ground. Just as Lincoln teased that there is no specific length that a man’s legs should be, a fixed amount of time should not define an investment cycle. A better way to delineate a cycle is by a complete rotation through some meaningful measure.

In the case of one particular type of cycle, value versus growth in equity markets, a useful measure of a cycle is a round-trip in the relative valuations between these two groups back to the typical valuation relationship between them. Looked at in this way, the current value/growth cycles around the world have stretched for an unusually long amount of time, most now between six and ten years old and counting. The growth phase of these cycles peaked around 2020. Since then, value has led on the path back to normal, with more value recovery still to go in most markets.

Many economic and financial measures go through cycles – economic cycles (GDP, profits), financial market cycles (bull/ bear stock markets, interest rate cycles) and intra-market cycles (value versus growth, large versus small). Often, the performance of an investment approach or manager is referred to as “performing well through the cycle”. There is validity to this idea since all approaches have environments during which they may tend to perform better or worse.

Value/growth cycles often impact the performance of investment approaches since coherent moves in value vs. growth can cause large swathes of stocks to outperform or underperform (e.g., due to a market fad, mania or panic) in a manner that is less dependent on the merits of the stocks themselves. We’ve seen this before. In the late 1990s, growth stocks took off, leaving less exciting value stocks far behind and begging the question: Is value dead? Of course, value wasn’t dead – it was just unpopular.

So how should one measure such cycles? There are various approaches. Time, as described above, is not a great approach since cycles often don’t obey neat timelines. Another approach would be based on returns, looking for the relative return between two groups or asset classes to “round-trip” – that is, if one initially had higher returns, one would consider the cycle complete once the returns of the other had caught up. But not all asset classes should be expected to have the same longterm return. For example, stocks and bonds have known and understandable differences in expected returns. Value and growth stocks also have a reasonable expectation of differential returns, and this has generally been observed in equity markets around the world. Historically, in most markets, value stocks have outperformed growth stocks over the long run due to value stocks typically being priced too inexpensively as compared to their fundamentals. As long as market participants continue to make this mistake, value’s outperformance is sustainable despite the growing cumulative outperformance of value stocks over growth stocks.

Even if the returns of two groups are generally expected to be similar over time, there could be a period of differential returns between the two due to real and sustainable improvements in fundamentals of one group relative to another. Such returns might not be expected to be “given back”.

However, by looking at moves in relative valuations instead of relative returns, we can more clearly identify temporary sentiment swings towards one group (which should be expected to reverse out), above and beyond the fundamentals. A group cannot sustainably outperform solely through relative valuation increases, which cannot rise indefinitely. Historically, such relative valuations have eventually reverted each time that they deviated from their long-term averages. Thus, relative valuations can be a better tool for defining and measuring cycles.

The current value/growth cycle has unfolded in parallel all around the globe. We’ve seen it play out in the U.S., developed international markets and emerging markets (EM). We’ve seen it in both large-cap stocks and small-cap stocks. While some specifics have varied from market to market, growth valuations (in particular, relative to value) had steadily risen around the world, in most cases peaking in 2020. Depending on the measure used, the degree of the valuation dislocation was comparable to that seen at the peak of prior major cycles and, in some cases, even larger than past extremes. But even more unique than the magnitude of the dislocation is the duration of time it has taken for this cycle to play out – both on the path towards its most extreme point as well as on its journey back towards normalcy.

Exhibit 1 shows, for each of six different equity asset classes, the lengths of value/growth cycles: typical past cycles, previous longest ones and the current one. In most asset classes, the current cycle is one of the longest we’ve seen, in some cases by a wide margin. While the current cycle has been very long for all markets, the EM cycle in particular has been remarkable, lasting over a decade and still going!

Exhibit 1: For each asset, the median and maximum length of prior value/growth cycles is shown along with the length of the (still to be completed) cycle. ^{1, 2}

Not only have the current cycles been unusually long, but in most asset classes the depth of this cycle has also been one of the largest experienced. We use depth of a cycle to denote the percentage drop from the median value/growth relative valuation to the trough value/growth relative valuation of the given cycle. Exhibit 2 shows, for each asset class, the depth of this cycle in comparison to the depths of both typical prior cycles and the deepest prior cycle.

Exhibit 2: For each asset class, the median and maximum depth of prior value/growth cycles is shown along with the depth of the current (still to be completed) cycle. ^{1, 2, 3}

In each of these asset classes, the trough of the current cycle appears to have already been reached – i.e., growth has peaked. Yet, despite the advanced age of the current cycles, in many asset classes there is still a large value recovery remaining in order to complete the cycle and restore valuations to normal. Exhibit 3 shows, for each asset class, how much the valuation discount of value stocks has already recovered since the trough of the current cycle as well as the remaining recovery needed for value to return to its historical valuation relationship with growth. In most of the asset classes, the value recovery from the trough back to normal has only progressed about halfway or even less in some cases.

Exhibit 3: For each asset class, the current discount of value to its median relative valuation vs. growth (i.e., recovery remaining to reach normal valuations) is shown along with the amount of discount that has been recovered so far since the trough of the current cycle.^1,2,3

A typical rule of thumb is that three years, or surely five years, is enough time for a cycle to play out from start to finish. So, it is common for investment approaches and investment managers to be evaluated on three- to fiveyear periods and for that to be considered a fair assessment. But as we see, the current value/growth cycle is already much longer than that and, in many places, still has significant value recovery left to complete. Therefore, understanding where value/growth is in its cycle, and how a manager’s performance should be impacted by its completion, is key to understanding their expected prospective returns through the end of a cycle and one’s general view of their ability to outperform “thru the cycle”.

Cycles that are “shallow” – in which the valuation dislocation between value and growth is relatively small – are not very consequential (regardless of their duration) since their impact is limited. But “deep” cycles matter a lot. The current cycle was both deep and has taken a historically long time to play out. This has allowed some to assume (or assert) that the world has somehow changed. In the midst of this extended cycle, it may have been easy to believe (or convince others) that markets were now subject to new rules, since if returns were going to revert, they typically would have done so sooner. But the years since 2020 have delivered a harsh dose of reality to those who (again!) claimed value was dead.