Growth vs value and the US elections - Capital Economics
Asset Allocation

Growth vs value and the US elections

Asset Allocation Update
Written by Oliver Jones
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We have argued elsewhere that a significant reversal in the outperformance of US “growth” stocks versus their “value” peers is likely only once coronavirus is being contained across major economies, something which still seems some time away. But, if and when that happens, three other factors may influence the size and duration of any relative rebound in value stocks – all of which hinge on the forthcoming elections.

  • We have argued elsewhere that a significant reversal in the outperformance of US “growth” stocks versus their “value” peers is likely only once coronavirus is being contained across major economies, something which still seems some time away. But, if and when that happens, three other factors may influence the size and duration of any relative rebound in value stocks – all of which hinge on the forthcoming elections.
  • The first issue is the size of any future fiscal support. The chances of a big deficit-financed expansion appear greater under a Democratic “clean sweep” than any other election outcome. The current split Congress is struggling to reach any agreement whatsoever, with the Democrats arguing for a much larger package than the one proposed by the Republicans. (As a crude yardstick, on the spending side the latest package supported by House Democrats is worth around $2.2tn, reduced from an initial $3tn in an unsuccessful bid to win cross-party support. The Republicans favour a package worth roughly $1.6-1.8tn.)
  • By boosting near-term economic growth, a larger fiscal deal might favour value over growth. In general, firms whose stocks are in the growth category are more likely either to be part of a new industry which is growing as a share of total economic activity, or to be consolidating their grip over a market. So, all else equal, they may be affected less by the short-run fluctuations of the economic cycle than their value peers. Chart 1 helps illustrate this point. Value outperformed in the mid-2000s economic boom prior to the Global Financial Crisis; underperformed in the crisis as the economy tanked; kept pace in the initial strong rebound that followed; then lagged in the subsequent years of weak economic growth and again in the pandemic.
  • The second such issue is antitrust policy. A key recent development on this front was the release of the Democratic-controlled House Antitrust Subcommittee’s report from its long-running investigation into four of the five “big tech” firms. The report recommended sweeping changes to toughen up enforcement generally, plus a range of measures aiming to curtail the power of big tech firms specifically – including a potential mandate to break them up – which we summarised here. (You can read the full proposals here.)
  • There is no guarantee that these proposals will make it into law. (See here and here.) But the chance of it happening would be greater under a Democratic clean sweep (particularly a big one). While there is a bipartisan consensus on the diagnosis that big tech is too powerful, the parties are divided on the correct cure. A key Republican on the Subcommittee agreed with his Democratic colleagues that antitrust enforcement should be better funded, but described nearly all the more radical proposals as “non-starters”.
  • The kind of changes proposed by the Subcommittee would probably affect growth stocks more than value ones. The share of the tech giants targeted by the report all fall into the growth category according to MSCI’s classification (and most other conventional growth/value classifications), and together comprise more than a quarter of the entire MSCI USA Growth Index. The report’s proposals aim to address many of the processes that we have argued have helped to drive the surge in the prices of those shares in recent years.
  • The third issue is corporate tax reform. If elected, Joe Biden plans to unwind partly the cut to the headline rate enacted under President Trump, and make other changes to the system designed to close exemptions and reduce the incentive to shift profits overseas. Firms in the IT, biotech and pharmaceutical sectors have among the lowest effective tax rates (see Chart 2), partly because they have been big beneficiaries of profit shifting, so in principle they may stand most to lose. Their shares mostly fall into the growth category.
  • However, it is fair to say that the potential effects of this issue are far less clear-cut than those of the other two. Experience suggests that the devil will be in the detail when it comes to identifying the impact on different firms. In fact, we have made the case that, depending on the exact formulation of Biden’s reforms, they could even end up hitting firms outside the sectors named above harder. It will be hard to say for sure until we have a lot more detail about what kind of legislative changes might actually happen.
  • Setting aside the ambiguity over the effects of potential corporate tax reform, the general conclusion from the analysis above is that a big Democratic clean sweep would open the door to several developments which might favour value over growth stocks. (Betting and prediction markets suggest that that outcome has become more likely in the past couple of weeks – but it is still far from fully discounted.)
  • On their own, these developments might not be enough to turn the tide sustainably – the slight outperformance of value stocks as the market-implied probability of the Democrats taking full control has risen this month is tiny compared to their prior coronavirus-induced underperformance. But once the virus is being brought under control, the effects on the relative performance of value vs growth could be much larger following a decisive victory for the Democrats than any other election outcome.

Chart 1: Ratio Of Total Returns, MSCI USA Growth Index Vs MSCI USA Value Index (End-2019 = 100)

Chart 2: S&P 500 Median Effective Tax Rates In FY 2019, Excluding Real Estate Sector (%)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


Oliver Jones, Senior Markets Economist, oliver.jones@capitaleconomics.com