Growth stocks enjoying best year-to-date outperformance since 1979 — but value can soon bounce back, Bank of America says

• Stocks just closed out their best third-quarter performance in a decade, but Bank of America expects growth stocks to soon take a back seat to value names.
• The Russell 1000 Growth Index opened a 36 percentage-point lead over its value-focused peer on Thursday. That’s the biggest outperformance for growth stocks in data going back to 1979, Bank of America said in a note to clients.
• Still, investors’ heavy concentration in growth sets value up for a bounce-back. The bank recommended high-quality value stocks to ride out election-season volatility and the US economic recovery.
• Positioning, valuation dispersion, and “an expected recovery in the profits cycle” point to a near-term rally for value, the team of strategists led by Savita Subramanian added.
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The stock market is hot off of its best third-quarter performance in a decade, and growth names are set to dominate through the rest of the year.

Though stocks sank through the start of September, the S&P 500 still notched a 9% gain in the quarter ended Thursday. Mega-cap stocks such as Apple, Microsoft, and Amazon are on track to post their best year since 1998. Further down the size spectrum, the Russell 1000 outperformed its mid-cap and small-cap peers in the third quarter.

The strong performance proved the “no alternative to stocks” argument is going strong, Bank of America strategists led by Savita Subramanian said in a note to clients. Even after volatility climbed in September, long-dated Treasurys and investment-grade bonds only gained 0.2% and 1.7%, respectively. Gold was on track to beat the S&P 500‘s return before falling 3.6% in September.

Within stocks, large growth names have been the clear favorite in 2020. The Russell 1000 Growth Index was up 24% year-to-date on Thursday, trouncing the corresponding value-focused index by 36 percentage points. That lead was the largest in Bank of America data going back to 1979.

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The outperformance was largely fueled by strong momentum heading into the third quarter, the bank said. Despite serving as an early favorite through the coronavirus pandemic, the tech sector finished the quarter in fourth place out of the S&P 500’s 11 groups. Consumer discretionary, materials, and industrials led the three-month upswing.

Still, value stocks will soon have their spot in the limelight, the strategists said. Though growth names still enjoy support from Federal Reserve policy, the bank recommended high-quality value stocks to ride out election uncertainties and lingering virus risks. The economic recovery continues to aid value’s rebound, the team said. Market volatility will likely intensify in the weeks heading into the election, making higher-quality equities investors’ best bet.

Despite September bringing a small rotation into value, the group has “more room to run,” Bank of America said. “An expected recovery in the profits cycle, positioning, our [dividend discount model], and valuation dispersion all favor value over growth.”

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