investment viewpoints
Growth or value: which equity style are macro dynamics benefiting most?
How can macroeconomic analysis inform different views about equity performance relative to geography and style? This week’s edition of Simply put dives into growth, population, productivity and capex for long-term guidance on the growth versus value debate across regions.
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Shedding light on the equity divide
Developments in the first quarter polarised the investment community, with some arguing in favour of US stocks while others viewed the recent rally in emerging markets (EM) and European stocks as a sustainable trend. This lack of consensus often boils down to a stylistic preference: the US market is typically characterised predominantly by growth stocks, while European and EM markets tend to oscillate between value and deep value orientations.
How can macroeconomic analysis shed light on this geographic and stylistic divide? Economists often refer to foundational growth theories to understand such dynamics. The short answer is the current trend in productivity growth tends to favour growth stocks, which are more prevalent in the US market. Conversely, a cycle driven by capital expenditure (capex), which is more supportive of quality stocks, could potentially undermine them. The long answer is explored in the sections below.
Is growth really Solow?
Since the seminal paper by Robert Solow in 19561, well-trained economists around the globe have dissected the long-term drivers of economic growth through three key factors: investment, which accounts for capex and housing investment, and expands the capital stocks; population growth; and productivity, which accounts for what the first two factors cannot. The economist Moses Abramovitz famously referred to this residual productivity as the "measure of our ignorance," a nod to economists accepting the limitations of their own models.
Recently, discussion about a potential rise in this residual has increased, as productivity appears to be playing a larger role in explaining parts of global growth. It's compelling to test this intuition with empirical data. Figure 1 illustrates the results of our decomposition of world growth since 1960, focusing on the recent changes in these three fundamental factors in a clear visual of the structural changes. One of the most striking patterns observed is demographic. From 1961-2021, world population growth has slowed, consequently diminishing its contribution to overall economic growth.
The contribution from investment has also decreased over time, albeit at a slower pace. Productivity, on the other hand, has been a significant driver of growth during various key periods: the 1960s, the late 1990s during the internet bubble, and more recently, with the increasing significance of the tech sector. This shift is further illustrated in the right-hand chart, showing a noticeable change in the mix of drivers of world growth over the past 15 years.
Today, despite demographics playing a new role, potential growth appears higher, primarily driven by a surge in productivity – not only in the US, and significant enough to be captured in world-level data.
FIG 1. World growth decomposed across Solow factors shown in time series evolution (left) and recent situation (right)
Source: Bloomberg, LOIM. For illustrative purposes only. As at May 2024. The time series evolution covers the period 1961-2021.
As investors, this prompts a critical question for us: does this shift in growth drivers translate into tangible opportunities?
Productivity means growth, but capex means quality
A straightforward approach to addressing the tangible investment angle involves examining the impact on equity returns during periods when growth and its components are unusually high. Figure 2 illustrates the performance across the excess returns of the market factor, as well as the size, value, quality and growth factors during these distinct periods of unusual growth (proxied by their first historical quartile). The insights from this chart can be summarised as follows:
- High growth typically correlates with greater equity returns, unless the growth is driven by unusually large population growth
- The most effective strategy to capitalise on periods of higher growth is to invest in growth stocks
- Periods of large population growth tend to benefit small-cap and value stocks more
- Periods with higher than usual investment tend to negatively impact growth-style stocks and favour quality stocks more
- Periods of strong productivity growth, likely similar to the current environment, tend to disadvantage small-cap stocks but benefit growth-style stocks
Beyond the recent fluctuations in market prices, macro-aware investors should remember the link between the structural macroeconomic context and structural market performance. As population growth gives way to productivity growth, the recent shift from small cap to growth stocks is likely to persist, unless investment emerges as a new primary driver of global growth. This does not, however, preclude periods of solid performance for smaller stocks as the cycle combines itself with these structural elements – and we have highlighted recently how the current period could support their valuations.
FIG 2. Market and factor returns as a function of periods of high growth and high growth component periods
Source: Bloomberg, LOIM. High periods correspond to the first quartile of growth and of each of its contributor under the Solow model. For illustrative purposes only. As at May 2024. Past performance is not an indicator of future results.
Such fluctuating growth drivers can provide worthwhile signals for investors. As risk-based investors, we use a dynamic trend overlay that has been following the positive news flow on growth indices. Such overlays aim to respond tactically to shifts in the landscape. And since they are based on different market and macro signals, they offer a further source of diversification.
Simply put, the recent rally in growth stocks probably mirrors productivity growth. A progression of investment in the economy could benefit quality stocks more.
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises is designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- In contrast to last week, our growth indicator rose in the US and China on the back of monetary conditions data and was flat in the eurozone
- Our inflation nowcaster continues to point higher, in particular in the US
- For monetary policy, the indicator declined slightly in the US and remained stable in other regions
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
source:
1 Solow, Robert M. A Contribution to the Theory of Economic Growth. The Quarterly Journal of Economics, Volume 70, Issue 1, February 1956, Pages 65–94. Accessed 10 May 2024.
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