Style Update: Where are we in the Market Cycle?

• Historical Performance: Analysis of 10 style cycles since 1979 reveals significant outperformance by growth during the Great Growth Regime (GGR) of the 2010s, emphasizing the importance of understanding historical trends in style performance.
• Impact of Great Growth Regime: The extraordinary cumulative overperformance by growth during the GGR highlights the influence of market cycles on style returns and the need for cautious forward expectations, considering factors beyond past performance.
• Current Market Insights: Integration of the Russell Style methodology indicates that the prevailing growth regime is approximately 75% of the typifying cycle on a performance basis, with potential implications for investment strategies amid changing market dynamics.

This analysis explores how the Russell Style methodology is more than just an allocative tool, but it can also serve as a diagnostic lens for market positioning.  Its rigorous three-input model^[1] offers a standardized approach to breaking down market trends, with the dichotomous split between Growth and Value styles providing a more comprehensive understanding of market risk factors.  Indeed, the systematic view of style suggests the current growth cycle is both more nuanced than imagined and may have yet to culminate.

Industry P/E multiples are a staple in finance, but they fall short in capturing style regime rotation and may present a biased signal.  The chart below illustrates the trailing Price to Earnings ratios for the eleven industry sub-indices of the Russell 1000 Index, both at their present and median values over the past ten years.

The 54.6% valuation premium of Technology versus its historical median value appears jarring at first, but the underlying data are more subtle.  For instance, the Russell 1000 Index broadly trades at a 20.0% premium to its 10-year median P/E, and the Russell 1000 Growth Index strikes a 31.3% premium to its 10-year median.  These levels are certainly elevated, but they are not necessarily alarming or indicative of an imminent transition from growth to value—style regimes can become incredibly extended before rotating^[2].

More remarkable than the Technology multiple expansion is that the Russell 1000 Value Index is only modestly above its long-term median valuation.  If pricing is stretched from a P/E perspective, it is not necessarily a systemic phenomenon market-wide; the Energy industry trading at a 28.7% discount to its 10-year median provides an excellent counterpoint.

The chief limitation of relying on industry multiples for historical valuations is that the industry groups themselves are moving targets, and Technology is the posterchild for this condition.  If we conceive of the tech industry as its own portfolio, we’ve seen allocative weight shift from low-multiple categories, such as hardware, to much higher-multiple categories such as software and semiconductors. The latter two categories witnessed a 14-point increase in weight over the past decade.

This intra-industry turnover is a significant contributor to the elevation in P/E ratios, but crucially tech valuations have not expanded homogeneously.  For instance, Software P/E multiples currently stand at only 21% over their median values, in line with the Russell 1000 Index overall, while Semiconductors are at a blistering 298% premium!  These challenges in achieving apples-to-apples comparisons limit the utility of industry multiples in assessing market valuations, much less broader equity risk cycles.

If not industry multiples, what is a more encompassing measure of market cyclicality?  By leveraging the Russell Style methodology, we can measure the ratio of P/E multiples of the Russell 1000 Growth and Value Indices over the past 30 years.  Essentially the chart below begs the question, how much more is the market willing to pay for double the earnings growth at any point in time?

This ratio approach clearly demarcates both medium- and long-term trends in market regimes, including key inflection points. Extremes in both directions are identified as well; there was a moment in 2009 where growth earnings could be purchased for 57 cents on the dollar compared to value earnings!  Fascinating is that the current growth multiple premium relative to value is at neither a local or historical maxima.  Not only was a peak ratio of 2.068 achieved in June 2023, but the relative price of growth has receded steadily over the intervening nine months.

With the cost of growth earnings now 1.734 times that of their value counterparts, relative growth multiples stand at the 79th percentile for their 30-year history, or 3/4 of a standard deviation above the median value of 1.44.  This consistency of application is one reason why style is such a helpful framework to assess market positioning—it aggregates myriad factors in a simple to read monitor.

The present retracement in relative valuation aside, growth remains richly priced, but far from unprecedented levels that may signal an immediate rotation to value. Just how long can heady growth cycles persist, even when perceived to be overvalued?  Historically, growth cycles have on average outperformed by 50.1% before value reversion commenced, and presently we stand at 37.59% outperformance by growth since the current regime began in January 2023.

This mean figure excludes the Great Growth Regime (GGR), an atypical 15-year period from 2006 to 2021, which garnered 444% cumulative overperformance by growth.  This exorbitant number should not guide forward expectations, as it reflects more the compounding of returns in a rising market than the actual pace of style returns.  The extreme longevity was the critical factor; at this point into the GGR cycle (measured by the number of months since the start of the regime), growth had only outperformed value by 12.1%!

By integrating the Russell Style methodology into our market analysis, we can see the prevailing growth regime stands at roughly 75% of the typifying cycle on a performance basis.

Moreover, the retrenchment in the P/E multiple premium  of growth relative to value may suggest the cycle has yet to reach its zenith, even if investors are anticipating that growth exhaustion and a value resurgence may be on the horizon.  These insights underscore the merits of the Russell Style methodology not just as a benchmarking and asset allocation resource, but also as a standardized tool for evaluating market cycles.

1. Russell Style Indexes are built using three highly representative growth and value characteristics. Our style indexes use one value characteristic (book-to-price ratio), and two growth characteristics (medium-term forecast earnings growth rate based on I/B/E/S two-year forecasts, and sales-per-share growth rate based on five-year historical sales). Roughly 70% of the available market capitalisation is classified as all-growth or all-value. The remaining 30% of stocks have some portion of their market value in either the value or the growth index, depending on their relative distance from the median value score.

2. See Trends in growth and value | LSEG