Value stocks have been flashing warning signs for the past two months. Turns out it was just a false alarm.
If you’ve ever sat through a 401k benefits meeting at work or met with a financial advisor, you’ve likely heard of growth and value stocks. Benefits managers and financial advisors love to talk about the benefits of diversifying between value and growth stocks.
They’re not wrong. Diversifying between these two stock styles will give you a stronger, more balanced portfolio.
Growth stocks tend to outperform value stocks when the stock market starts to rebound. This happens because traders tend to sell — and take profits on — the conservative value stocks in their portfolio as they become more confident. They then take that money and put it into flashier, more aggressive growth stocks.
Value stocks, on the other hand, tend to outperform growth stocks when the stock market pulls back. This happens because traders tend to sell — and take profits on — the aggressive growth stocks in their portfolio as they become more nervous. They then take that money and put it into cheaper, more conservative value stocks.
Having both in your portfolio can help you balance out your returns.
Watching for Growth Versus Value Warning Signs
Interestingly, because these two stock styles tend to underperform and outperform in different market environments, we can also watch them for warnings about where the stock market is headed.
By comparing growth and value stocks, we can see whether Wall Street is expecting the stock market to rise or is preparing for a potential pullback.
When growth stocks are in favor, we can be increasingly confident that traders believe the stock market is likely to do well. When value stocks are in favor, we can be increasingly confident that traders believe the stock market is likely to do poorly.
You can easily compare the performance of these two stock styles by creating a relative-strength chart comparing two exchange-traded funds. In this case, the Vanguard Growth Index Fund ETF (NYSEARCA:VUG) is the first ETF in the pairing and the Vanguard Value Index Fund ETF (NYSEARCA:VTV) is the second.
When the VUG/VTV relative-strength chart is moving higher, it tells you that VUG is outperforming VTV. This means the S&P 500 is likely doing well. Conversely, when the VUG/VTV relative-strength chart is moving lower, it tells you that VUG is underperforming VTV and the S&P 500 is likely feeling some bearish pressure.
The comparison of the VUG/VTV relative-strength chart and the S&P 500 (SPX) chart in the figure below shows how the VUG/VTV chart tends to diverge from the S&P 500 chart before major trend changes.
VUG/VTV Compared to the S&P 500
Source: TradingView
The VUG/VTV relative-strength chart started trending lower in mid-2018 before the S&P 500 topped out in September. In late 2018, before the S&P 500 bottomed out the day after Christmas, the VUG/VTV relative-strength chart was trending higher.
Recently, the VUG/VTV relative-strength chart has been trending lower while the SPX has been breaking to new all-time highs.
This divergence was a warning sign that traders may be losing confidence in the current bullish rally.
Luckily for the bulls on Wall Street, that warning sign turned out to be a false alarm.
If you look at the closer view of the VUG/VTV relative-strength chart in the figure below, you will see that the chart just completed a bullish “wedge” continuation pattern by breaking up through the down-trending resistance level that started forming in late August.
VUG/VTV Daily Relative-Strength Chart
Source: TradingView
This chart tells us that growth stocks are taking the lead once again and are starting to outperform value stocks.
Seeing this gives us confidence the bullish trend in stocks is likely to continue well into the holiday season.
The Bottom Line on Growth Stocks
You’ve got to take what the market is giving you. This market continues to give us bullish gains, so we’re going to keep selling put writes.
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