Asset bubbles and the investment road ahead
The large current deviation of growth-stock valuations relative to our fair-value estimates also helps make our case. The size of the deviation is similar to the one at the height of the dot-com bubble. When the bubble popped, value proceeded to outperform growth by 16%, annualized, over the next five years. We can’t be certain that growth stocks represent a bubble, but Vanguard’s global chief economist, Joe Davis, recently wrote about the pitfalls of low-quality growth stocks.
We believe that cyclical value-growth rotations are rooted in investor behavior and that investors become more price-conscious when profit growth is abundant. Since 2008, corporate profit growth has been insufficient to sustain value stocks.
Vanguard expects inflation to normalize and eventually exceed the Federal Reserve’s 2% target this year and next. Corporate profits should strengthen amid economic recovery from the pandemic. Still, their impact on the “fair value of value” may be modest. The ultimate driver of the coming rotation to value stocks, then, is apt to be a change in investors’ appetite for risk.
For investors with sufficient risk tolerance, time horizons, and patience, an overweight to value stocks could help offset the lower broad-market returns we expect over the next decade.